But there are several problems with this account. First, even if true, it would mean that Japan’s bubble and crash weren’t really caused by the Plaza Accord, but by policy mistakes. By 1987, it should have been clear that the yen’s appreciation wasn’t causing a slowdown in exports or growth. Keeping the BOJ’s foot on the monetary accelerator for years after Plaza seems like an unforced error, rather than a necessary response to the currency deal.
Second, it’s far from clear that low interest rates are a major cause of financial bubbles. In theory, raising rates should reduce prices, by raising the opportunity cost of capital. That, in turn, could puncture the irrational exuberance, extrapolative expectations or chain of speculation that sustains a bubble. For this reason, monetary policy makers sometimes cite bubbles as a reason to avoid setting rates too low.
But in reality, the link between interest rates and bubbles is weaker than one might think. There’s only a weak correlation between interest rates and housing-price appreciation. Lab experiments generally find that paying higher interest rates does nothing to discourage bubble formation. And a number of countries have found that it’s hard to restrain rising asset prices via government policy without sending the economy into recession, meaning that the cure might be worse than the disease.
So it seems highly unlikely that the Plaza Accord caused Japan’s economic crash and lost decade, even indirectly through monetary policy. So China shouldn’t be afraid of coming to a similar arrangement with the U.S.
But there’s also the possibility that such an arrangement wouldn’t accomplish much after all. If a doubling of Japan’s currency didn’t put a dent in its trade surplus with the U.S., removing China’s capital controls might also leave the two countries’ trade imbalance intact. It’s still a good thing to do, since China should eventually try to make the yuan a global currency. But it might not be the big victory Trump is looking for.
This article provided by Bloomberg News.