Connecting The Dots …

Posted in Business, Current Affairs, Gold Reserves by Anuraag Sanghi on October 11, 2008

The Dollar Yuan Rumba

The Dollar Yuan Rumba

Dollar Devaluation

1973-1985. The Japanese were strutting on the world stage.

1973-1985. The Japanese were strutting on the world stage. In their hubris, one Japanese businessman declared that the only world-class product made in USA was maple syrup. The Japanese manufacturing juggernaut seemed unstoppable. Japanese management was the first lesson and the last word in business schools. Companies like Xerox, FedEx, Motorola adopted various ‘QIP’ systems – quality improvement processes.

Finally, the Americans decided that the yen-dollar exchange rate was the culprit. In 1985, the US worked out a deal whereby the US dollar was devalued. Only it was not called a devaluation. It was called the Plaza Accord.

Without a formal devaluation, the Plaza Accord allowed Americans to depreciate the dollar against other currencies – especially the Japanese Yen. Intense negotiations spread over nearly a decade followed. During a crucial negotiation in Japan, in 1992, a stressed out George Bush Sr., vomited and fainted.

The Oil-Dollar Tango

The Oil-Dollar Tango

Endaka – and the end of the Japanese run

After the Plaza Accord, the Japanese team went back home and prepared their industry for endaka – high yen prices.

From August 1971 through April 1995, the yen’s value ratcheted up from 360 to the dollar to 80 to the dollar. This was primarily because some U.S. industries, anxious about their eroding share of world markets, put political pressure on American politicians. The American government in turn put pressure on Japan’s politicians and central banking officials to keep raising the value of the yen against the dollar. With some support from academic economists, American producers argued that a higher-valued yen would help their products sell better in competition with Japanese products and therefore reduce the American trade deficit.

Net outcome, by the mid 1990s, the Japanese juggernaut was halted. Japan had to remain contented with being the world’s second largest economy. George Soros thought,

the prospect of Japan’s emerging as the dominant financial power in the world is very disturbing, not only from the point of view of the United States but also from that of the entire Western civilization

For the next 10 years, the Japanese economy stagnated, investments stagnated. Their dream of supplanting the US as the world’s largest economy were over – for now at least.

Stuffed Tigers

The 90s was decade of the Asian Tigers. Korea, Malaysia, Thailand, Indonesia, Singapore were all set to replace Japan as the axis of world economy. India especially came out as a distant plodder against these countries. Lee Kuan Yew, held forth on the Indian character was faulty – and could not compete with the Chinese-Confucian value-set.

Then followed the Asian Crisis. Mahathir Mohammed claimed that the 1997 Asian Crisis was a foreign conspiracy. Specifically, he named George Soros as the master mind behind the Asian Crisis. 9 years later, Mahathir made up with George Soros – and retracted his charge.

The ostensible reason was that investors in the Asian Tigers were funding long-term investments from short-term borrowings – a classic mismatch. The rapid withdrawal of foreign funds impacted development of these economies to the extent of a decade.

Has It Come To This? (Cartoon by David Horsey from seattlepi.com).

Has It Come To This? (Cartoon by David Horsey from seattlepi.com).

The 2 trillion trap

After the Asian crisis, China was in a better position to resist American pressure for renminbi revaluation.

That resistance to renminbi revaluation, in turn, caught China, in another trap. China has US$ 2 trillion worth of rapidly depreciating foreign reserves.

Which brings us to India!

What will it be

What are the threats to the Indian economy! Will it be a ‘sudden’ collapse in software and outsourcing? Or will it be a severe contraction in gems and jewellery exports? Can it be a 3 year drought due to global warming?

7 Responses

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  1. Galeo Rhinus said, on October 11, 2008 at 6:16 pm

    One typo – 1977 – you mean the 1997 – Asian crisis.

    There are two distinct elements to the story. One was a currency crisis and another was the “tiger” exuberance fueled by the Institute of Moral Hazard. (A sarcastic name for the IMF).

    Let’s leave the currency crisis and Soros’ posturing out for a second – since that lesson is at least being debated.

    A more important lesson – which does not get any attention is how the IMF works.

    Say a large western bank was investing in Indonesia during the “tiger” years of the 1990s. Any lender – logically should be very concerned with the “quality” of the asset that was being purchased as well as the valuation of that asset. If either of the two fails a test – the lender should not lend.

    Yet – in the roaring mid nineties – these western banks – closed their eyes to lending. In fact as asset prices reached bubble levels – the banks did not stop lending.


    Most economists – on the implicit payroll of the IMF – remained quiet. But the reason why this irrational exhuberance went unchecked was because the banks expected to be bailed out by the IMF.

    So – even when they realized that they were possibly making risky loans – they knew that IMF would come over and bail them out.

    Who were the borrowers – in most cases – they were large wealthy and politically connected families in Indonesia.

    So the west invested the “capital” for the “growth” of Indonesia… and when the bubble collapsed, logic would have dictated that the investors should have lost their shirts. They did not.

    IMF came along – paid them a check for their losses, and then forced Indonesia to raise their taxes to pay 35 billion over the next 20 years. The rice farmer in Indonesia today pays higher taxes because that money goes to service the debt to the IMF. That was Indonesia’s “belt tightening.”

    Malaysia was a combination of a monetary and asset value speculation. Mahathir Mohammed did the best he could – but simply could not match the wits and the political machinations.

    Merrill Lynch – who owned about a billion dollar worth of thai baht derivatives – simply “sold” them at their original cost (they were worthless when the baht crashed) to S, Korea’s “loyal” government… soon the won crashed…

    …Asia faltered because they could not exhibit political leadership to face the west.

    What was India’s lesson?

    India had a reasonably strong currency regime – which needs to be reassessed today – did not need an overhaul. However – what about Moral Hazard?

    Why did investors think they will be bailed out by the IMF? Because the political leadership never gave any signal to the investors that they will lose their shirts if the bottom falls out…

    …what did India do in the late 90s?

    The Indian government became an investor in the IMF. A puny amount of 100 million or so… yet – it gave a signal to any future investors that the IMF is no longer welcome in India.

    As the economic contagion reaches India – an important reason why India in all likelihood will remain standing – is because India might have the will to not subsidize foreign losses…

    …domestic losses? that’s another story…

  2. Anuraag Sanghi said, on October 12, 2008 at 6:55 am

    I agree about the poor rice farmer paying higher taxes to IMF … which bailed out the lenders … who anyway made their profit … from investing money which came by printing excess dollars .. which is because of he Bretton Woods I&II …

    western banks – closed their eyes to lending

    They closed their eyes because they were given money by their central banks at 1%-3% rates of interest- which they could on lend for 6%-11% returns. Western banks could ‘borrow’ as much as they wanted at these ridiculous rates – from their respective central banks. So, if any one bank decided to be a careful lender, their market cap, their profits, bonuses, stock options suffered. Raghuram Rajan stopped at pointing out the skewed reward system – but didnt go any further. So, Western Banks had little choice – join the party at no cost or stay out of the party at a high cost.

    In the meantime, the printing continued. Ben Bernanke stopped giving out M3 figures.

    I think the Moral Hazard story is overwrought.

    How is it that each time, some competition to the West comes up, the crisis follows soon after? That is where connecting the dots comes in …!

    Japan was rewarded for becoming a ‘client’ state with a undervalued yen, which boosted manufacturing in Japan, which helped in the reconstruction … which was then halted by the Plaza accord …

    Same story with the Asian Tigers and China …

    China after 1971 Nixon-Mao handshake, was rewarded for distancing itself from the Soviet Union .. with FDI … with the MFN status … with the WTO membership …

    Asia faltered because they could not exhibit political leadership to face the west

    The leadership to face up to the West is related to the fact that these ASEAN states are all client states of the US – and belong to the past SEATO alliance of the US.They have all been weaned on the milk of Western superiority – in matters critical.

    By taking token steps, these ASEAN states differentiate themselves from the ‘corrupt’ West – being anti-drugs, for instance. You only have to read Lee Kuan Yew’s various ‘enlightened’ views to understand this ideological bankruptcy of ASEAN.

  3. Galeo Rhinus said, on October 12, 2008 at 6:08 pm

    Lending and M3 figures.

    Actually these are different time frames.

    During the asian crisis – the M3 figures were published – there were stopped only during 2003.

    Moral Hazard – Overwrought?

    In some cases yes. The other explanation is a conspiracy – which is always easier to explain. So – Indonesia can perhaps be explained as a conspiracy of the “client” and S. Korea as well. But – Malaysia – despite elements within it that were western clients – did a lot of right things under Mahathir Mohammed – yet faltered. In the case of Malaysia – a conspiracy is a stretch. Investor psychology cannot easily be ignored.

    Political Leadership and Client states.

    Would you not agree that the lack of the former leads to the latter?

  4. Hiroshima | Worlds Biggest Cities said, on October 13, 2008 at 3:11 am

    […] Connecting The Dots … […]

  5. Anuraag Sanghi said, on October 13, 2008 at 7:48 am

    Of course, the Asian crisis and M3 Ben Bernanke, are at different times. The M3 data stopped coming out sometime in Oct 2006. I was just saying the printing continued. And later they stopped giving the M3 figures too. I am laying out the sequence of events pre-and post Asian crisis.

    Well actually ‘conspiracy’ theories are logically when a events acquire a life of their own. In India it is called ‘Karma’. Once, individuals, societies or countries start down a certain path, events follow. The West call them conspiracies – and I use the word ‘conspiracy’ rarely – under the above ‘advice.’ I am talking about a pattern of events.

    Political Leadership and Client states. – I did say that they are related.

  6. senthil said, on September 24, 2011 at 4:09 am


    I would like to know, whether you want the dollar to be devalued against indian rupee? This would certainly bring down the software industry, and other export oriented industries. But it will also bring a balanced economy for indian society, which will strengthen it in long terms..

  7. Anuraag Sanghi said, on September 24, 2011 at 1:49 pm
    Senthil – I am not saying that dollar should go up or down in value.

    There are two approaches to this dollar:valuation equation. One if the USCAP approach which Europe, Japan, Asian Tigers, China have used to grow their economy. Basically, it means, that the US allows select countries to keep their currencies at a lower level – and thereby reduce the price of exports to the US. With low price for imports, American goods become expensive, and the US consumer starts to buy imports from that country.

    The other approach is the Indian approach – whereby the Indian currency is pegged at a higher than real level than the dollar. This means that India’s imports are cheaper – and our exports are more expensive. This forces our exporters to work much harder, and limits the export markets for India. The biggest benefit is that imports of oil and gold, become cheaper for India.

    The context of each country makes them select their policy options – and I largely believe that Indian policy is suitable for India.

    This however has little to do with the role of the dollar in international trade. Here we have a situation that the poor of this world subsidize the richest nation in the world. This is clearly not acceptable – and must change.

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