BEIJING/TOKYO Beware the "Japanese disease," for its specter haunts China.
Let the yuan rise too quickly -- like the yen's rapid appreciation in the 1980s -- and China will hurtle toward the same sort of asset price boom that ended in a bust and a decade of economic malaise for Japan.
Or so goes a school of thought that is so pervasive in Beijing that it has shaped -- some say, distorted -- the country's exchange rate policy and will incline the government toward a plodding pace for yuan appreciation even after it eventually de-pegs the currency from the dollar.
"It is a conspiracy theory," said Xu Qiyuan, a researcher at the Chinese Academy of Social Sciences. "A lot of Chinese people think that the United States forced Japan to appreciate in order to make the economy collapse, and that it is trying to do the same thing to China."
In the face of a barrage of U.S. criticism, Beijing has held the yuan at about 6.83 to the dollar for nearly two years as the government tried to cushion its economy from the global financial crisis.
Beijing let the currency climb 21 percent against the dollar from 2005 to 2008, but some American economists think it remains as much as 40 percent undervalued given the country's bulging current and capital account surpluses.
Chinese officials say their ultimate goal is an internationalized yuan -- a free-floating currency that could even rival the dollar -- but they envision this happening over the course of decades, not years, let alone months.
"We maintain that the yuan should not appreciate too much, as we must avoid the problems that confronted Japan after its overly fast appreciation," Zhu Baoliang, a researcher with the State Information Center, a top government think-tank, said last month.
"Our policy proposal will always be for gradual refinement."
At the center of this powerful narrative is the Plaza Accord, the pact between the United States and other major economies in 1985 to devalue the dollar against the yen and the German mark.
Over the next two years, the yen climbed about 46 percent against the dollar. Foreign capital flooded into Japan, stock prices soared and a property bubble swelled.
The bust at the start of 1990 condemned Japan to a lost decade of economic growth as banks, firms and households all struggled to repair their balance sheets.
The moral is simple enough.
"China must learn from Japan. It was forced to appreciate the yen, dealing a blow to domestic industries and leading to deflation and more than 10 years of economic depression," the official Xinhua news agency said in its summary of an academic conference in March about how to reform the Chinese currency.
Many economists think it is just a matter of time before Beijing resumes appreciation.
But since China's default mode is exchange rate incrementalism, investors are betting on a yuan rise of just 1.5 percent over the next 12 months, offshore forwards markets show.
Indeed, the most these forwards have priced in recently for one-year appreciation has been just over 3 percent, even as speculation swirled authorities were on the verge of releasing the currency from its dollar link.
THE RIGHT LESSONS
Parallels between Japan of the 1980s and present-day China are imperfect but strong enough to offer Beijing guidance.
Like China today, Japan was a roaring economy with a large trade surplus, a buoyant property sector and a currency widely seen as undervalued.
However, the right lessons to draw might be almost diametrically opposed to the received wisdom in China, Japanese economists say.
"The biggest mistake Japan made was over-estimating the harm of a strong yen. It expanded fiscal and monetary stimulus too much to stem yen rises, triggering a bubble and the subsequent economic downturn," said Koichi Haji, chief economist at NLI Research Institute in Tokyo.
Falling import costs meant the yen's rise offered some good to Japanese companies, despite dire warnings from the business sector, he said.
Hideki Hayashi, global economist at Mizuho Securities in Tokyo, has sympathy for gradual currency appreciation, but says Japan's undoing was that it delayed the inevitable, making the Plaza Accord a painful but necessary adjustment.
"Japan left the yen undervalued for too long despite its rising economic power, neglected efforts to spur domestic demand and ended up experiencing rapid yen appreciation," he said.
DON'T BE AFRAID
Xu at CASS is part of a small but increasingly vocal group of Chinese economists who are trying to show that there is no causal link between currency appreciation and economic stagnation.
In his research, he has cast a wider net, looking not just at the yen's rise in the 1980s, but also its gains from 1969-1978, as well as the mark's similar trajectory during both periods.
"Germany did not experience a bubble like Japan or a lost decade," Xu said. "Monetary policy was excessively loose in Japan. This is what led to an asset bubble."
Huang Yiping, an economist at Peking University, was even more explicit at a conference last month: "What we are doing is actually repeating Japan's mistake -- refusing to let the currency appreciate and implementing an ultra-loose monetary policy."
Since a mini-revaluation in 2005, China's top leadership has declared a commitment to perfecting its exchange rate mechanism. Many think this means that the government wants to manage the yuan with greater reference to a basket of currencies, weakening its link to the dollar.
Given the size of its market, Beijing may well be more resistant to outside pressure than Tokyo, allowing it more time to reform the yuan.
But even China's power has limits.
"As we can see from intervention by the Japanese government, we cannot control foreign exchange rates. Eventually, the same will apply for China," said Tohru Sasaki, foreign exchange strategist at JPMorgan Chase in Tokyo.
"As China becomes more involved in the global economy, they will eventually need to face adjustments."
(Additional reporting by Zhou Xin; Editing by Ken Wills and Neil Fullick)