China ‘Contagion’ Is Wildcard As Goldman Sachs Revisits Japan’s 1990s

No advanced economy, arguably, hated the 1990s more than Japan. The fallout from that decade’s debt crises, deflation and political drift is still with Tokyo as politicians try to straddle past mistakes and future opportunities.

A new report from Goldman Sachs is sure to trigger policymakers’ PTSD from that period. In it, strategists led by Kamakshya Trivedi predict the 1990s will soon come back as the yen falls to levels not seen since June 1990.

Trivedi sees the yen hitting 155 to the dollar within six months from about 146 now. That’s largely thanks to the Bank of Japan continuing to stick with quantitative easing.

“As long as the BOJ remains far from hiking rates and equities stay reasonably well supported, the yen should continue to trend weaker,” the strategists write.

Yet a big question is written between the lines in bold font: how might China react to Tokyo’s beggar-thy-neighbor policy ploy?

China’s economy, it goes without saying, is having a surprisingly shaky 2023. No one thought that China’s post-Covid-19 revival would go smoothly. But Asia’s biggest economy falling into deflation and facing fresh default dramas was on very few economic Bingo cards.

It follows that as Chinese leader Xi Jinping looks to halt the drop in growth, demand and consumer prices, a weaker yuan sure would help. Nothing might get China a bit closer to its 5% growth target faster than jolting exports via exchange rates.

Now that Japan seems set on reverting to the 1990s, currency-wise, why wouldn’t Xi think China has scope to do the same?

It’s not that simple, of course, as the 2024 U.S. election crisis gets into full swing. Just about the only thing on which President Joe Biden’s Democrats and the Republican Party that Donald Trump still leads agree is being hard on China. Few issues would anger Washington faster than Beijing appearing to manipulate the yuan.

Yet leveling that charge becomes harder if U.S. ally Japan, Asia’s second-biggest economy, is doing the same. Knowing this, might Xi’s Communist Party roll the dice and drive the yuan-dollar rate lower?

One wonders as “contagion” talk makes the rounds in Asia. “China’s huge economy is the planetary body around which all others in Asia revolve,” says economist Vincent Tsui at Gavekal Dragonomics. “That dependency stems from trade linkages—whether as suppliers of raw materials or functioning in some complex supply chain—and from financial relationships through capital flows and currency markets. Hence, to borrow an old adage, when China sneezes, Asia catches a cold.”

Two years after China Evergrande Group’s default spotlighted troubles in the property sector, other major developers are missing bond payments. In recent weeks, economists around the globe have been Googling “Country Garden” and other companies spooking markets everywhere.

Nor are there many hints of optimism on the macroeconomic front. Recent data on industrial production, retail sales and business confidence suggest 2023 is a year Xi’s inner circle can’t wait to see end. In July, both exports and imports dropped sharply. Exports fell by 14.5% year on year, while imports dropped 12.4%.

The People’s Bank of China has been trying to avoid big easing moves. It hardly wants to encourage a return to the bad behavior causing boom/bust cycles and unproductive investment shackling Beijing with excessive debt.

But in top-down China, major PBOC policy moves are led by President Xi and Premier Li Qiang. Might they tell PBOC Governor Pan Gongsheng that a weaker yuan is just the ticket to livelier growth?

The yuan, after all, is only down 5.6% this year versus 11.7% for the yen. Why wouldn’t Xi give the PBOC the green-light to guide the yuan lower by another 5 percentage points or so, in league with the yen? Beijing could argue it’s merely keeping pace with Tokyo in order to address deflation.

There are good reasons why China might not. One is the risk of trolling a Washington political establishment agitating for a China fight. Another: squandering progress Beijing made in recent years internationalizing the yuan. Resorting to valuation would set things back.

But as the yen veers back toward the 1990s, and contagion talk stalks China, there’s no reason to think Beijing will take the trend lying down.

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