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By Eadie Chen TOKYO, Nov 21 (Reuters) - China's usual defence in keeping a tight rein on the yuan is that it wants to avoid the trap that Japan fell into in the 1980s when it bowed to foreign pressure to let the yen surge, inducing a decade of stagnant growth. Like Japan then, China is under growing pressure to let its closely managed currency rise at a faster rate to ease global economic imbalances, underlined by its whopping foreign exchange reserves of $1.4 trillion. A high-powered European delegation is due to press the case in a visit to Beijing next week, followed in short order by a high-level U.S. group in December. But Japanese-based analysts say another reading of Japan's history suggests Beijing's concerns about loosening the reins on the yuan may be misplaced and the longer it delays the more danger there is of developing an asset bubble that will burst. Their reading suggests Japan developed an asset bubble because policy makers didn't allow the yen to appreciate fast enough at an earlier stage, fuelling a current account surplus and allowing the buildup of pent-up yen demand that was finally unleashed when Tokyo released its hold on the currency in 1985. "Japan at that time, like China now, feared appreciation. However, the market forces finally pushed it to have a big jump in the yen. This is quite likely to happen in China too in the near future," said Chi Hung Kwan, a senior fellow at Nomura Institute of Capital Markets Research. "It's not an issue whether you like it or not because the final outcome will be determined by market forces," he said. While the yen's gain sowed the seeds of Japan's asset bubble, analysts say it was fuelled and eventually burst by efforts to loosen monetary policy as a way to curb the yen's appeal, a reminder to China for today that should it release the reins on the yuan, it may have to keep monetary policy tight. SIMILAR EXTERNAL IMBALANCE Like Japan in the 1980s, China is an emerging economy with huge growth potential and increasing global economic clout. Japan had a current account surplus of 3.7 percent of gross domestic product in 1985, the year of the Plaza Accord, when it agreed as a member of the Group of Five top industrial countries to push the dollar lower to reduce a bulging U.S. trade deficit. The consequence was a higher yen. China's current account surplus was 11.6 percent of GDP in the first half of 2007 and rarely does a day pass without its major trading partners demanding the yuan be allowed to rise at a faster rate to reduce its bulging trade surplus. "Because the current account surplus has got so big, a large one-off appreciation, say 10 to 15 percent is needed," said Takatoshi Ito, an economics professor at Tokyo University, The next show of official concern over the yuan's exchange rate will come next week with the visit to Beijing of a European Union delegation, to include the head of the euro zone's grouping of finance ministers, the president of the European Central Bank and the EU Economic and Monetary Affairs Commissioner. U.S. Treasury Secretary Henry Paulson is due to visit the Chinese capital next month. Their complaint is that the yuan has gained less than 10 percent against the dollar since July 2005, when China revalued the currency and abandoned a dollar peg. Indeed, the currency has fallen against the euro since then. The slow rise against the dollar has parallels with the yen, which Tokyo allowed to rise just a few percent a year between 1971, when it was floated, and 1985, when the Plaza Accord was agreed. RISKS OF DELAY In the 10 years after the Plaza Accord, the Japanese currency tripled to reach 78 per dollar. The Nikkei share average and land prices in big cities tripled, funded by overseas investment and cash gushing into Japan from its trade surplus. So unless China takes action now, it may also face an asset bubble that could burst. Signs of a bubble are already there, some analysts say, pointing to the Shanghai stock market which has doubled this year alone and property prices in big cities that have risen at a double digit pace. "There are only two possible outcomes: the authorities may take some strong tightening steps to prick the bubble or some event may occur to lead to the bursting of the bubble," said Toyoo Gyohten, president of International Monetary Affairs Institute in Tokyo and a former Japanese vice finance minister. "The bubble is already forming, so the more you delay a larger appreciation, the bigger the bubble gets and the harder it becomes when the bubble bursts," Ito said. The key risk for China is that an undervalued exchange rate will fuel inflation, which in October hit its highest level in nearly 11 years. "In the long run, the government can at best control the nominal exchange rate, but not the real exchange rate. There is a trade off between price adjustment and exchange rate adjustment," said Nomura's Kwan. So Beijing has a choice -- higher inflation or a higher exchange rate, he said, adding that the answer should be the latter. "The 1989 Tiananmen incident occurred when China was facing double-digit inflation, and social unrest is the last thing the Communist party wants to see," Gyohten said. (Editing by Neil Fullick)
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