Bob,
You're absolutely correct. My attempt to shoehorn growth rates into the determination of exchange rates was ad hoc and unrigorous. I was attempting to give "credit" to the great American growth machine, using assumptions I found intuitively appealing, but not clearly formulated. However, using textbook inflation methods, as you suggest, only proved a circular argument: i) assume dollar/yen 250 is the equilibrium, ii) have politicians broker an overvalued yen (let's say 125 for convenience), iii) since external purchasing power is doubled, this dampens domestic inflationary forces, iv) Because at 125 there is no inflation, 125 is justified as the equilibrium rate.
But I've gathered the money numbers now and I'll attempt to give this a more thorough and precise treatment. I started with money figures from Jan 85, before the Plaza Accord. Since then, Japan M2+CD and broad liquidity have increased by 108% and 121%, while US M3 and liquid assets has increased by 85% and 91%. Now, I hope you agree with me that money growth is equal to the sum of inflation and productivity growth, because that's the foundation of my argument. For simplicity, let's first assume that the productivity growth in the US and Japan for past baker's dozen years is equal, say at 60%. That means ~65% inflation in Japan versus ~40% in the US. And we KNOW that the US grew far faster than Japan during this time. So in fact, the portion of the money stock growth not due to productivity growth increased much faster in Japan than the US. This is why I suggested that dollar/yen, if equilibrium is 250 in 1985, should be even higher now.
The puzzling thing, though, is that the rapid monetary inflation in Japan was not accompanied by much consumer inflation. Here, the answer is less clear. I think it's because of Plaza, the rapid yen appreciation, and the resulting asset bubble that soaked up all the money being printed. The rapid money growth ended with the prickling of the bubble in the early 90s, and has remained fairly low since. |
