A Puzzle Resolved: Japan's High Currency Value and Trade Surplus

Abstract

Trade between the United States and Japan has been characterized by Japanese surpluses and American deficits. This prolonged pattern of trade has caused much debate in political, social, and academic spheres. In the political and social spheres the American public is angered by what is perceived as unfair Japanese trade polices. The academic debate concerns the disparity between economic theory and the real situation of trade. Theory predicts that a strong currency and a current account surplus can not coexist indefinitely. As the yen appreciates, American imports to Japan should increase and Japanese exports to the United States should decrease thereby eliminating Japan's current account surplus. However, since the 1985 Plaza Announcement, the yen appreciation has been accompanied by a Japanese trade surplus. This paper looks to reasons rooted in both American and Japanese policies and institutions that account for the counter—theoretical coexistence of Japan's strong yen and trade surplus.