The fear that a deepening trade war could wreck the global economy has analysts and economists once again pining for the mid-1980s, when the U.S. and the world’s other major economic powers struck a deal, known as the Plaza Accord, to weaken the dollar.
An end to the present turmoil surrounding U.S.-China trade tensions “may require no less than a global grand bargain,” wrote Thierry Wizman, economist at Macquarie Group, in a Wednesday note. The best such grand bargain would see President Trump “ditching the protectionist mind-set” versus China, he said. In return, China, the European Union and Japan would agree to a depreciation of the U.S. dollar which on a trade-weighted basis stands near a three-year high.
The weakness of other currencies — particularly the euro
and the Chinese yuan
— have angered Trump, who has made such complaints part of the basis of his repeated criticism of the Federal Reserve. Trump contends the Fed should be moving to loosen monetary policy more quickly.
The U.S. dollar’s strength and Trump’s complaints have led traders and economists to contemplate the prospect of direct intervention in the currency markets by the U.S. to weaken the dollar, even though White House economic adviser Larry Kudlow last month said the administration had ruled out that option. Economists and currency watchers also hold doubts that a unilateral effort would prove effective, particularly against a global economic backdrop in which other major central banks are moving to loosen monetary policy in the face of subdued inflation pressures and growing worries over economic growth.
Meanwhile, the intensification of the U.S.-China trade war is blamed for increased market volatility as investors fret about the potential hit to the global economy. The Dow Jones Industrial
tumbled more than 700 points on Monday and the S&P 500
saw its biggest one-day plunge of 2019 after China allowed its yuan currency to weaken more than expected following Trump’s announcement last week of additional tariffs on imports from China.
So it’s no surprise that the 1985 agreement, hashed out in meetings between the U.S., Japan, West Germany, France and the U.K. at New York’s Plaza Hotel (which Trump acquired in 1988 and was forced to sell four years later by his lenders), is stirring memories once again. Indeed, Axios on Wednesday wrote about speculation over the long-shot prospect for a “Mar-a-Lago Accord.”
Observers note that nostalgia for the accord waxes and wanes quite regularly:
The accord was a struck after a sharp, extended run-up by the U.S. dollar versus other currencies, including the
German mark, French franc, and British pound
The dollar’s rise came after the Paul Volcker-led Federal Reserve had all but wrung inflationary pressures out of the U.S. economy, something a strong dollar had helped accomplish. The U.S. currency was also boosted by rising fiscal deficits during President Reagan’s terms in office. All in all, the dollar rose by around 50% versus major currencies between 1980 and 1985, a move that contributed to a growing U.S. trade deficit and growing calls for protectionist measures in Congress.
The dollar retreated around 40% in the following two years, with the trade balance also improving, after a typical lag, recalled economist Jeffrey Frankel of the Harvard Kennedy School in a 2015 paper, while Congress refrained from enacting new trade barriers. In fact, it was so successful that global policy makers agreed two years later, in a Paris agreement known as the Louvre Accord, to work together to arrest the dollar’s fall.
Indeed, the chart below, from Macquarie, illustrates why the deal is held in high esteem:
“The Plaza Accord is widely held as the most successful episode of coordinated FX intervention…,” wrote Kamal Sharma, director of G-10 FX strategy at Bank of America Merrill Lynch, in a Wednesday note.
But, Sharma emphasized, the deal was built on specific economic pledges, including a U.S. promise to reduce the federal budget deficit, a Japanese pledge to loosen monetary policy, and an agreement by Germany to cut taxes. The coordinated currency-market intervention, therefore, was part of an overall strategy aimed at addressing the internal and external imbalances that had driven the dollar higher.
Today’s strong dollar and rising twin U.S. fiscal and trade deficits offer intriguing parallels to the mid-1980s. Conflicts over trade policy and worries over a rising rival economic power — with China now in place of Japan then — are also strong echoes of the period.
But observers aren’t holding their breath for policy makers to come up with something similar in the near future. For one, Chinese policy makers are certainly aware that the deal is blamed in part for Japan’s subsequent lost decade.
And while the Plaza Accord showed that successful grand bargains among economic rivals were possible, it was forged when the U.S. was the undisputed leader of the world economic order, Wizman noted.
“But in a multipolar, de-globalizing world, such an outcome remains unlikely,” he acknowledged. “And a grand bargain is highly unlikely over the next few months, when Europe is sluggish and would make the case that the euro isn’t cheap enough.”
Sharma noted another big difference between now and the 1980s. Many countries, including France and Germany, were concerned about the weakening of their currencies versus the U.S. dollar in 1985, which made them eager to join in efforts to weaken the dollar. “Now, FX is an essential part of the policy armory,” he said. “Europe and Japan are now more accepting of FX weakness than FX strength.”