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Changing Fortunes: The World's Money, the Threat to American Leadership, and the Future of the Renminbi

BOOK Changing Fortunes: The World's Money and the Threat to American Leadership, Volcker, Paul A.
New York: Times Books; ©1992
is the most authoritative text I have read recently on exchange rate theory and international monetary practices. When I saw in the translator's preface that the original English version of this "Changing Fortunes" was published 25 years ago,

[!IMPORTANT]
it was co-authored by former Federal Reserve Chairman Paul Volcker and former Bank of Japan Governor Yasuo Matsushita. This important work delves into the evolution of the international monetary system and its impact on the global economy, especially in the context of the post-World War II era.
"Changing Fortunes" is quite a unique and interesting book that records significant historical events from the perspective of those who experienced them.
The two heavyweight authors: one is Paul Volcker, born in 1927, graduated with a bachelor's degree in economics from Princeton University in 1949, and received a master's degree in political economy from Harvard University in 1951. He studied at the London School of Economics through the Rotary Ambassadorial Scholarship Program from 1951 to 1952. He served as a junior economist at the Federal Reserve Bank of New York from 1953 to 1957, worked at Chase Manhattan Bank from 1957 to 1962, served as Assistant Secretary for Monetary Affairs at the Treasury from 1962 to 1965, was Vice President of Chase Manhattan Bank from 1965 to 1968, served as Under Secretary for Monetary Affairs at the Treasury from 1969 to 1974, was President of the New York Federal Reserve from 1975 to 1979, and served as Chairman of the Federal Reserve from August 6, 1979, to August 11, 1987 (the 12th). Volcker is considered one of the architects of America's post-war economic position and even the "greatest Federal Reserve Chairman." His successor was Alan Greenspan, and Volcker's policies are believed to have laid a solid foundation for Greenspan.
The other is Yasuo Matsushita, born in 1931, graduated from the University of Tokyo's Faculty of Economics in 1955, and entered the Ministry of Finance (later split into the Ministry of Finance and the Financial Services Agency), where he held various positions including Director of the International Finance Bureau and Financial Officer. After retiring from the Ministry of Finance in 1989, he served as a visiting professor at Harvard University, Princeton University, and the University of St. Gallen, and was President of Tokyo Bank from 1992 to 1996. Since 1995, he has served as Chairman of Japan's International Monetary Research Institute. He worked in the Ministry of Finance for 34 years and participated in almost the entire process of the yen's internationalization, including the "Plaza Accord," earning him the title of "Yen Master." This book is not in the usual co-authored format; rather, each chapter is first written by Volcker, followed by Matsushita. They narrate the decision-making situations and domestic perspectives of the United States and Japan regarding the same historical period and events. It is as if high-ranking officials responsible for negotiations in today's China-U.S. trade friction were to write memoirs together 20 years later, reviewing their respective internal decision-making processes at that time.

How much of the post-war economic decline in the United States is justifiable, how much is a result of abandoning excessive global ambitions, and how much is self-inflicted harm? Former Federal Reserve Chairman Volcker and former Japanese Finance Minister Matsushita review the decline of the Bretton Woods fixed exchange rate system, the oil crisis of the 1970s, efforts to curb inflation, and the international debt crisis of the 1980s in alternating chapters, exploring this issue. This seminar is based on a joint lecture series by the two authors at Princeton University's Woodrow Wilson School and provides valuable global perspectives on the fragile U.S.-Japan alliance and the prospects for establishing a new framework for foreign trade and exchange rate cooperation. Volcker cautiously notes the U.S. tendency towards protectionism, while Matsushita emphasizes that Japan must open its markets and that the U.S. can no longer act as the world's police alone.
The seminar discusses three long-term forces affecting the global economy and their implications for businesses and policymakers:

• Geopolitical shifts from a globally cooperative order to "de-globalization";
• The spread of new technologies through the "Fourth Industrial Revolution," especially artificial intelligence;
• The steady increase in public and private debt in most countries.

De-globalization leads to reduced investment and the disintegration of global value chains, thereby lowering global potential economic growth and living standards. The Fourth Industrial Revolution will promote periods of productivity growth and low inflation, accompanied by severe disruptions in the labor market. High and rising debt levels trigger a range of risks associated with financial fragility. Additionally, the rise of populism coincides with skepticism about the value of central bank independence, potentially aligning the incentives between governments and heavily indebted households, favoring a return to inflationary policies in the future. The article concludes with a series of implications and long-term policy impacts. It stems from a speech first delivered at the Spruce Meadows Changing Fortunes Roundtable held in Calgary, Alberta, in September 2019.

[!IMPORTANT]
Both authors are "well aware of the challenges, contradictions, and dilemmas of the past system, as well as the successes and failures, and these firsthand experiences are not unrelated to the future. This is why we want to document our experiences in a book." (Author's preface)

Main Takeaways#

• 1. The relationships between nations are always intertwined with political and economic interests, and power dynamics change, leading to various alliances; there are no permanent friends or enemies. For example, in U.S.-Japan relations, after World War II, the U.S. supported Japan to contain China and the Soviet Union, but Japan's trade surplus threatened U.S. economic interests, prompting the U.S. to suppress Japan. The establishment of diplomatic relations with China also had certain constraints on Japan (Matsushita believes that "it was probably around that time (1971) that the U.S. began to see Japan as an economic rival and decided to take a hard line against Japan. I believe the Nixon administration was also considering the possibility of using China to contain Japan in post-Vietnam Asia."). The U.S. is not willing to let any one country become too powerful but prefers to have several rivals keep each other in check.

• 2. As the leading nation on Earth or the "hegemon," there are both benefits and costs; being the world's primary currency is one prominent reflection. Volcker points out that
     for the U.S., having the dollar at the center of this system has some tangible benefits. It indeed gives us financing flexibility and some policy flexibility. But to keep this system running, there are also real costs. One of them is the special responsibility to maintain a sound currency that other currencies can rely on. Without a dominant global power willing to take on leadership responsibilities and maintain rules, what kind of fixed exchange rate system can function? In political science jargon, such a dominant country is called a hegemon, and the U.S. has played this role quite well for over 20 years. It is not that simple. In 1960, American economist Triffin proposed in his book "Gold and the Dollar Crisis: The Future of Free Convertibility" that "although the dollar has achieved the status of an international reserve currency, countries must use the dollar as a settlement and reserve currency to develop international trade, which will lead to a long-term deficit in the U.S. balance of payments; and the premise for the dollar to be the core of international currency is that the U.S. must maintain a long-term surplus in its international trade balance. These two requirements contradict each other, thus creating a paradox." This is known as the "Triffin Dilemma." This is a challenge faced by any international currency. Japan and Germany, in order to avoid this problem, did not want the yen and the mark to become core international currencies. The internationalization of the renminbi also faces this issue.
• 3. Currency depreciation or appreciation involves both economic conditions and face issues.
  • The two authors write interestingly about currency appreciation and depreciation. The U.S. reluctantly sees the dollar depreciate, while Japan fears that it will affect exports and the economy, expressing "strong fear" of yen appreciation. Volcker writes:
    Exchange rate issues are somewhat complex. Economists sometimes hold the view that exchange rates are purely technical issues. After considering substantive factors such as inflation, productivity, and interest rate differences, exchange rate changes are merely adjustments to balance discrepancies. I may be old-fashioned, but I have always believed that a strong currency is usually a good thing, representing vitality, strength, and competitiveness. Of course, this view may be a bit exaggerated. During Reagan's term, some of his aides promoted the benefits of a strong dollar, sometimes to the point of boasting. These benefits were later proven to be temporary, but their intuition was not wrong. Of course, currency depreciation generally means higher import costs and reduced foreign exchange earnings from exports. In other words, the country becomes poorer rather than richer, which is not something to celebrate. Looking back at this history: in the 1950s, the dollar was strong, but except for a few exceptional years, the dollar has been on a depreciation path since then. By now (1991), the dollar's exchange rate against the yen is only one-third of what it was in the 1950s, and only 40% of what it was against the German mark, which indicates the change in America's global position.
    Matsushita writes: (In 1971) "Out of a strong fear that the economy would suffer catastrophic impacts, people strongly resisted a significant appreciation of the yen." More satisfied consumers and overseas investment opportunities. After the Plaza Accord in 1985, "Prime Minister Nakasone and Finance Minister Takeshita, considered the main architects of the Plaza Accord, faced fierce criticism from their colleagues within the party." It was not until after 1988 that the benefits of a strong currency were widely recognized in Japan.

People's understanding of issues continues to deepen and change, but it is easy to forget how they were understood in the past. For example, whether floating exchange rates or fixed exchange rates are better. The fixed exchange rate system established by Bretton Woods made everyone feel that the world was orderly. Although adjustments to exchange rates were sometimes necessary due to changes in national strengths, many believed that floating exchange rates were a temporary phenomenon. Matsushita recalls that Federal Reserve Chairman Arthur Burns told the Japanese in 1973 that floating exchange rates would inevitably bring disaster to humanity, and once started, floating exchange rates would be difficult to end, possibly lasting from a few years to a century. It was not until the mid-1970s that floating exchange rates were approved by the IMF's amendment. However, by the end of the 1970s, floating exchange rates had been fully accepted by academia, politics, and business, and those still expecting fixed exchange rates were seen as marginalized.
During the fixed exchange rate period, the belief that floating exchange rates would automatically eliminate severe surpluses or deficits, eliminate crises, and stabilize the world, and the view that floating exchange rates would bring disaster to humanity, as Burns suggested, are not entirely correct or incorrect. A world of floating exchange rates is not stable, but it is not a disaster either; overall, it is still beneficial in reducing international income imbalances (though not as much as imagined), and is a better choice than fixed exchange rates, because fixed exchange rates cannot be "fixed" with the fluctuations of national economies, and many countries also intervene in the foreign exchange market to varying degrees.
Matsushita writes: "In the early floating exchange rate system, we still believed that long-term factors, such as purchasing power parity and balance of payments adjustments, would play a major role. However, later on, short-term capital flows and interest rate differentials became very important. In addition to those factors, the explosion of information technology also exacerbated the rapid shift of focus." Volcker also believes that "during the floating exchange rate period, it seems that what has happened is that the market ultimately lost a truly reasonable and sustainable exchange rate.

4. If one believes that exports are contributions to other countries, then imports are an even greater contribution. If other countries' products are cheaper and better than China's, and China imports a large amount, resulting in a large trade deficit, is this good or bad for China? The renminbi is not yet an international currency; if there is a large trade deficit, it will consume foreign exchange reserves. Once the foreign exchange reserves are depleted, what can be used for external payments? Even if it is an international currency, it cannot withstand continuous deficits. This also reflects issues of industry competitiveness and currency overvaluation. Improving industrial competitiveness is not something that can be done overnight; at least the currency should depreciate. Therefore, trade deficits are a headache for any country. This book is filled with various pressures that trade deficit countries exert on surplus countries. Opening domestic markets to allow other countries to profit from exports is a greater contribution to the world economy. But this requires the country opening its market to have strong confidence and other things to exchange, such as the U.S., which has core technologies (like chips) and culture (like American blockbusters) to export, and its people are wealthy and secure enough to consume.

• 5. Open economies require policy coordination among countries, which means a certain degree of compromise. Whether in the Treasury or the Federal Reserve, Volcker engaged in extensive coordination of domestic and foreign economic policies. He wrote with deep feeling: (Coordination of policies between countries) "For a politician, all of this means a certain loss of national sovereignty. Scholars would preach around this topic, emphasizing quite correctly at the philosophical level: entering an open world economy inevitably means a loss of autonomy; and as the total volume of world trade and investment grows, external factors will increasingly influence policies. However, for those who bear political responsibility for policy-making in the real world, the idea of coordination offends very sensitive political territory." Matsushita also mentioned that when the Japanese government agreed to the appreciation of the yen,
• • There seems to be a tendency among the Japanese media to take pleasure in humiliating their country, accusing bureaucrats of not being wiser in negotiations and claiming that we suffered a terrible diplomatic failure. * *
    But it was not that bad; due to Japan's large surplus, yen appreciation was inevitable. To what extent to insist on one's "principle" (that is, one's own interests) or to make compromises and concessions depends on the strength and strategic considerations of each country. Many policymakers now understand that international policy coordination requires each country to make certain concessions and compromises, while the public does not fully understand this, and sometimes voices populist or nationalist sentiments in the face of rational compromises.
• Matsushita mentioned that when the Japanese government agreed to the appreciation of the yen, "there seems to be a tendency among the Japanese media to take pleasure in humiliating their country, accusing bureaucrats of not being wiser in negotiations and claiming that we suffered a terrible diplomatic failure." But it was not that bad; due to Japan's large surplus, yen appreciation was inevitable. Another example of compromise is that President Carter accepted a proposal from Lawrence Klein (the 1980 Nobel Prize winner in Economics) to persuade surplus countries to expand their economies to address the U.S. trade deficit. In 1977, the U.S., Japan, and Germany reached a deal: Germany and Japan would take expansionary economic measures, while the U.S. would lift oil price controls to reduce oil imports. Volcker believes that "since 1978, there has been no such ambitious and politically significant coordinated effort." However, to coordinate international trade, it is difficult and not necessarily appropriate to change domestic policies to a large extent, even making commitments to domestic economic growth targets.

6. **People's understanding of issues continues to deepen and change, but it is easy to forget how they were understood in the past. For example, whether floating exchange rates or fixed exchange rates are better. The fixed exchange rate system established by Bretton Woods made everyone feel that the world was orderly. Although adjustments to exchange rates were sometimes necessary due to changes in national strengths, many believed that floating exchange rates were a temporary phenomenon. Matsushita recalls that Federal Reserve Chairman Arthur Burns told the Japanese in 1973 that floating exchange rates would inevitably bring disaster to humanity, and once started, floating exchange rates would be difficult to end, possibly lasting from a few years to a century. It was not until the mid-1970s that floating exchange rates were approved by the IMF's amendment. However, by the end of the 1970s, floating exchange rates had been fully accepted by academia, politics, and business, and those still expecting fixed exchange rates were seen as marginalized.
   During the fixed exchange rate period, the belief that floating exchange rates would automatically eliminate severe surpluses or deficits, eliminate crises, and stabilize the world, and the view that floating exchange rates would bring disaster to humanity, as Burns suggested, are not entirely correct or incorrect. A world of floating exchange rates is not stable, but it is not a disaster either; overall, it is still beneficial in reducing international income imbalances (though not as much as imagined), and is a better choice than fixed exchange rates, because fixed exchange rates cannot be "fixed" with the fluctuations of national economies, and many countries also intervene in the foreign exchange market to varying degrees.
   Matsushita writes: "In the early floating exchange rate system, we still believed that long-term factors, such as purchasing power parity and balance of payments adjustments, would play a major role. However, later on, short-term capital flows and interest rate differences became very important. In addition to those factors, the explosion of information technology also exacerbated the rapid shift of focus." Volcker also believes that "during the floating exchange rate period, it seems that what has happened is that the market ultimately lost a truly reasonable and sustainable exchange rate.

7. If one believes that exports are contributions to other countries, then imports are an even greater contribution. If other countries' products are cheaper and better than China's, and China imports a large amount, resulting in a large trade deficit, is this good or bad for China? The renminbi is not yet an international currency; if there is a large trade deficit, it will consume foreign exchange reserves. Once the foreign exchange reserves are depleted, what can be used for external payments? Even if it is an international currency, it cannot withstand continuous deficits. This also reflects issues of industry competitiveness and currency overvaluation. Improving industrial competitiveness is not something that can be done overnight; at least the currency should depreciate. Therefore, trade deficits are a headache for any country. This book is filled with various pressures that trade deficit countries exert on surplus countries. Opening domestic markets to allow other countries to profit from exports is a greater contribution to the world economy. But this requires the country opening its market to have strong confidence and other things to exchange, such as the U.S., which has core technologies (like chips) and culture (like American blockbusters) to export, and its people are wealthy and secure enough to consume.

• 5. Open economies require policy coordination among countries, which means a certain degree of compromise. Whether in the Treasury or the Federal Reserve, Volcker engaged in extensive coordination of domestic and foreign economic policies. He wrote with deep feeling: (Coordination of policies between countries) "For a politician, all of this means a certain loss of national sovereignty. Scholars would preach around this topic, emphasizing quite correctly at the philosophical level: entering an open world economy inevitably means a loss of autonomy; and as the total volume of world trade and investment grows, external factors will increasingly influence policies. However, for those who bear political responsibility for policy-making in the real world, the idea of coordination offends very sensitive political territory." Matsushita also mentioned that when the Japanese government agreed to the appreciation of the yen,
• • There seems to be a tendency among the Japanese media to take pleasure in humiliating their country, accusing bureaucrats of not being wiser in negotiations and claiming that we suffered a terrible diplomatic failure. * *
    But it was not that bad; due to Japan's large surplus, yen appreciation was inevitable. To what extent to insist on one's "principle" (that is, one's own interests) or to make compromises and concessions depends on the strength and strategic considerations of each country. Many policymakers now understand that international policy coordination requires each country to make certain concessions and compromises, while the public does not fully understand this, and sometimes voices populist or nationalist sentiments in the face of rational compromises.

Key Insights#

• 1. The relationships between nations are always intertwined with political and economic interests, and power dynamics change, leading to various alliances; there are no permanent friends or enemies. For example, in U.S.-Japan relations, after World War II, the U.S. supported Japan to contain China and the Soviet Union, but Japan's trade surplus threatened U.S. economic interests, prompting the U.S. to suppress Japan. The establishment of diplomatic relations with China also had certain constraints on Japan (Matsushita believes that "it was probably around that time (1971) that the U.S. began to see Japan as an economic rival and decided to take a hard line against Japan. I believe the Nixon administration was also considering the possibility of using China to contain Japan in post-Vietnam Asia."). The U.S. is not willing to let any one country become too powerful but prefers to have several rivals keep each other in check.

• 2. As the leading nation on Earth or the "hegemon," there are both benefits and costs; being the world's primary currency is one prominent reflection. Volcker points out that
     for the U.S., having the dollar at the center of this system has some tangible benefits. It indeed gives us financing flexibility and some policy flexibility. But to keep this system running, there are also real costs. One of them is the special responsibility to maintain a sound currency that other currencies can rely on. Without a dominant global power willing to take on leadership responsibilities and maintain rules, what kind of fixed exchange rate system can function? In political science jargon, such a dominant country is called a hegemon, and the U.S. has played this role quite well for over 20 years. It is not that simple. In 1960, American economist Triffin proposed in his book "Gold and the Dollar Crisis: The Future of Free Convertibility" that "although the dollar has achieved the status of an international reserve currency, countries must use the dollar as a settlement and reserve currency to develop international trade, which will lead to a long-term deficit in the U.S. balance of payments; and the premise for the dollar to be the core of international currency is that the U.S. must maintain a long-term surplus in its international trade balance. These two requirements contradict each other, thus creating a paradox." This is known as the "Triffin Dilemma." This is a challenge faced by any international currency. Japan and Germany, in order to avoid this problem, did not want the yen and the mark to become core international currencies. The internationalization of the renminbi also faces this issue.
• 3. Currency depreciation or appreciation involves both economic conditions and face issues.
  • The two authors write interestingly about currency appreciation and depreciation. The U.S. reluctantly sees the dollar depreciate, while Japan fears that it will affect exports and the economy, expressing "strong fear" of yen appreciation. Volcker writes:
    Exchange rate issues are somewhat complex. Economists sometimes hold the view that exchange rates are purely technical issues. After considering substantive factors such as inflation, productivity, and interest rate differences, exchange rate changes are merely adjustments to balance discrepancies. I may be old-fashioned, but I have always believed that a strong currency is usually a good thing, representing vitality, strength, and competitiveness. Of course, this view may be a bit exaggerated. During Reagan's term, some of his aides promoted the benefits of a strong dollar, sometimes to the point of boasting. These benefits were later proven to be temporary, but their intuition was not wrong. Of course, currency depreciation generally means higher import costs and reduced foreign exchange earnings from exports. In other words, the country becomes poorer rather than richer, which is not something to celebrate. Looking back at this history: in the 1950s, the dollar was strong, but except for a few exceptional years, the dollar has been on a depreciation path since then. By now (1991), the dollar's exchange rate against the yen is only one-third of what it was in the 1950s, and only 40% of what it was against the German mark, which indicates the change in America's global position.
    Matsushita writes: (In 1971) "Out of a strong fear that the economy would suffer catastrophic impacts, people strongly resisted a significant appreciation of the yen." More satisfied consumers and overseas investment opportunities. After the Plaza Accord in 1985, "Prime Minister Nakasone and Finance Minister Takeshita, considered the main architects of the Plaza Accord, faced fierce criticism from their colleagues within the party." It was not until after 1988 that the benefits of a strong currency were widely recognized in Japan.

People's understanding of issues continues to deepen and change, but it is easy to forget how they were understood in the past. For example, whether floating exchange rates or fixed exchange rates are better. The fixed exchange rate system established by Bretton Woods made everyone feel that the world was orderly. Although adjustments to exchange rates were sometimes necessary due to changes in national strengths, many believed that floating exchange rates were a temporary phenomenon. Matsushita recalls that Federal Reserve Chairman Arthur Burns told the Japanese in 1973 that floating exchange rates would inevitably bring disaster to humanity, and once started, floating exchange rates would be difficult to end, possibly lasting from a few years to a century. It was not until the mid-1970s that floating exchange rates were approved by the IMF's amendment. However, by the end of the 1970s, floating exchange rates had been fully accepted by academia, politics, and business, and those still expecting fixed exchange rates were seen as marginalized.
During the fixed exchange rate period, the belief that floating exchange rates would automatically eliminate severe surpluses or deficits, eliminate crises, and stabilize the world, and the view that floating exchange rates would bring disaster to humanity, as Burns suggested, are not entirely correct or incorrect. A world of floating exchange rates is not stable, but it is not a disaster either; overall, it is still beneficial in reducing international income imbalances (though not as much as imagined), and is a better choice than fixed exchange rates, because fixed exchange rates cannot be "fixed" with the fluctuations of national economies, and many countries also intervene in the foreign exchange market to varying degrees.
Matsushita writes: "In the early floating exchange rate system, we still believed that long-term factors, such as purchasing power parity and balance of payments adjustments, would play a major role. However, later on, short-term capital flows and interest rate differences became very important. In addition to those factors, the explosion of information technology also exacerbated the rapid shift of focus." Volcker also believes that "during the floating exchange rate period, it seems that what has happened is that the market ultimately lost a truly reasonable and sustainable exchange rate.

4. If one believes that exports are contributions to other countries, then imports are an even greater contribution. If other countries' products are cheaper and better than China's, and China imports a large amount, resulting in a large trade deficit, is this good or bad for China? The renminbi is not yet an international currency; if there is a large trade deficit, it will consume foreign exchange reserves. Once the foreign exchange reserves are depleted, what can be used for external payments? Even if it is an international currency, it cannot withstand continuous deficits. This also reflects issues of industry competitiveness and currency overvaluation. Improving industrial competitiveness is not something that can be done overnight; at least the currency should depreciate. Therefore, trade deficits are a headache for any country. This book is filled with various pressures that trade deficit countries exert on surplus countries. Opening domestic markets to allow other countries to profit from exports is a greater contribution to the world economy. But this requires the country opening its market to have strong confidence and other things to exchange, such as the U.S., which has core technologies (like chips) and culture (like American blockbusters) to export, and its people are wealthy and secure enough to consume.

• 5. Open economies require policy coordination among countries, which means a certain degree of compromise. Whether in the Treasury or the Federal Reserve, Volcker engaged in extensive coordination of domestic and foreign economic policies. He wrote with deep feeling: (Coordination of policies between countries) "For a politician, all of this means a certain loss of national sovereignty. Scholars would preach around this topic, emphasizing quite correctly at the philosophical level: entering an open world economy inevitably means a loss of autonomy; and as the total volume of world trade and investment grows, external factors will increasingly influence policies. However, for those who bear political responsibility for policy-making in the real world, the idea of coordination offends very sensitive political territory." Matsushita also mentioned that when the Japanese government agreed to the appreciation of the yen,
• • There seems to be a tendency among the Japanese media to take pleasure in humiliating their country, accusing bureaucrats of not being wiser in negotiations and claiming that we suffered a terrible diplomatic failure. * *
    But it was not that bad; due to Japan's large surplus, yen appreciation was inevitable. To what extent to insist on one's "principle" (that is, one's own interests) or to make compromises and concessions depends on the strength and strategic considerations of each country. Many policymakers now understand that international policy coordination requires each country to make certain concessions and compromises, while the public does not fully understand this, and sometimes voices populist or nationalist sentiments in the face of rational compromises.