Japanese Currency: A No-Go in US Trade Talks
Tokyo may be willing to compromise on a variety of issues, but not on its monetary policy.
By Xander Snyder
Remember the Trans-Pacific Partnership? Among the things it was intended to have accomplished, had it survived the 2016 U.S. election cycle, was the resolution of certain trade issues between the United States and Japan. Even as recently as last year, Tokyo had hoped that the U.S. would join the amended version of the TPP, now called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, to obviate the need for these potentially painful discussions. But it seems as though those talks have finally arrived. In mid-April, representatives from the two sides met in Washington for negotiations initiated in no small part by the threat of tariffs on Japan’s most important export: automobiles.
As with China, the most high profile of Washington’s trade disputes, the Trump administration’s explicit goal is to reduce the trade deficit with Japan, which currently stands at $68 billion – the vast majority coming from Japanese auto exports. But that’s where the similarities end. Washington is much less concerned with the national security implications of sensitive Japanese technologies than it is with Huawei in China, and Japan has already made most of the structural concessions the U.S. is demanding from China today. With Japan, the U.S. is instead asking for concessions that would nibble at the margins of the deficit such as increased Japanese purchases of agricultural products from U.S. farmers who have become collateral damage in the trade war with China. (Ironically, U.S. farmers are facing competition from countries that joined the TPP, since CPTPP-countries are now exporting to Japan at a lower tariff rate than can U.S. agribusinesses. This concern led Trump to at least briefly reconsider joining TPP last year.)
One issue on which the two will almost certainly disagree is currency. U.S. negotiators have added Japan to a list of countries it believes are manipulating currency. Currency manipulation is, of course, a loaded if nebulous designation. If a central bank maintains a loose monetary policy that results in a weakened currency, is that currency manipulation, or just run-of-the-mill monetary policy?
Insisting that monetary policy be excluded from trade talks is a lesson Japan learned from experience. In 1985, Tokyo signed an agreement, known as the Plaza Accord, that was designed to devalue the U.S. dollar relative to the yen by about 50 percent over a two-year period. As the dollar declined, the yen appreciated, making it more difficult to sustain the exports that fueled its economic growth. The Bank of Japan responded by loosening its monetary policy to keep the economy humming, which in turn expanded an already growing credit market, which by then had begun to extend ever riskier loans because of growing competition between banks in the first half of the decade. Debt grew, and when the debt-fueled asset bubble popped, it ushered in nearly two decades of stagnant growth, known not-so-fondly as the Lost Decade.
The financial calamity raises an obvious question: Why did Japan make such a bad deal? In 1985, the U.S. was beginning to embrace globalization, and the degree to which it would affect U.S. manufacturing was only beginning to become clear. At the time, Washington was concerned that if it didn’t protect domestic manufacturing, it would add fuel to the fire of broader, economy-wide protectionism. Former Treasury Secretary James Baker believed this could pose a great-depression-like risk, since “the isolationism and protectionism of that era [during the aftermath of World War I] in part helped cause the Great Depression.” Wary of protectionist policies that would undermine the post-WWII alliance structure between the U.S., Japan and Germany, the three countries (along with France and England) agreed to devalue the dollar so as to not upset the security equilibrium that had existed for 40 years.
Still, Japan’s economy today is different. For starters, it has already experienced decades of economic stagnation, leaving a bitter memory for policymakers to invoke and, if necessary, exploit. Second, Japan has already been extending cheap credit into the economy for decades – interest rates there hover at or below zero, with the BOJ’s short-term target interest rate at -0.1 percent. In other words, it does not have the flexibility to decrease interests rates by very much if any sort of external shock (such as a rapid currency revaluation) were to hit its economy. Aggressive monetary easing, moreover, is one of the three “arrows” of Abenomics – Prime Minister Shinzo Abe’s ambitious plan to drag the economy out of the lost decades for good – and not something Tokyo can sacrifice without abandoning its efforts to jumpstart flagging domestic consumption or without pulling the rug out from under an economy that has become accustomed to ultra-cheap credit.
Japan simply doesn’t have the flexibility, or frankly the desire, to allow trade talks to pollute its currency. Exports still account for nearly 18 percent of Japan’s economy, so it will be unwilling to make any major concession that allows for its monetary policy to be dictated by the U.S. Japan may be willing to make compromises throughout the negotiations, such as purchasing more U.S. liquefied natural gas and weapons – two things it needs anyway – or lowering tariffs on U.S. agricultural goods to CPTPP levels, but not on issues related to currency exchange rates. This will remain the third rail for Japan throughout its negotiations with the U.S.
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