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Japan's Malaise Was Made In America

The long bureaucratic struggle over whom to name as the next Governor of the Bank of Japan is over. Prime Minister Koizumi has chosen a career BOJ insider, Toshihiko Fukui, a man who is unlikely to rock the boat. The BOJ's hidebound policies are usually blamed for Japan's deflation. That guilt is real, argues Deepak Lal, but there is another culprit: American economic policy toward Japan.

It is now widely recognized that an unintended consequence of the "Asian" economic model was an increasingly inefficient allocation of capital. Japan's chronic slump is a case in point. Artificially low domestic interest rates in the late 1980s promoted capital-intensive investment, driving down the rate of return on capital from an average of around 12% in 1952-1973 to less than 2% in 1996.

But what still needs to be explained is the timing of Japan's boom and bust over the last 15 years, as well as the reasons for the duration of the country's ongoing slump. In their excellent book Dollar and Yen , Ronald McKinnon and Kenici Ohno provide an answer: the recurrence of endaka fukyo , a "strong yen recession," which the authors attribute to a "strong yen syndrome" rooted in persistent trade frictions between the US and Japan.

Ever since Richard Nixon took the dollar off the gold standard and exchange rates were floated worldwide, the US has sought to tackle its chronic bilateral trade deficit with Japan by pushing for a strong yen. Real and threatened action against Japanese exports forced Japan to comply rather than risk a trade war, with the Bank of Japan (BOJ) delivering the requisite appreciation through tight monetary policy.