Wednesday, August 13, 2014

85-9-22 Plaza Accord

.
America’s Greatest Trade Deal? 1985 Plaza Accord - Alt > .
Japan's Economy 

The Plaza Accord was an agreement by the G5 - US, Germany, Japan, France and Britain, to manipulate exchange rates to lower the dollar’s value in 1985. An agreement struck in New York’s Plaza Hotel. Between 1980 and 1985, the dollar had appreciated by a staggering 77% compared to its main trade partners. Leading to less competitive exports, cheaper imports and a rising trade deficit. By manipulating exchange rates the accord helped to lower the dollar's value, helping to reduce America’s trade deficits. But this did have some unintended consequences. Policies to increase demand, like tax cuts and government spending, helped create a massive credit and asset bubble in Japan. When this burst, Japan experienced a lost decade of low growth and deflation in the 90s. Ironically, the plaza accord was so successful at cheapening the dollar, it was largely reversed in 1987 by the Louvre Accord.

The Louvre Accord (formally, the Statement of the G6 Finance Ministers and Central Bank Governors) was an agreement, signed on February 22, 1987, in Paris, that aimed to stabilize international currency markets and halt the continued decline of the US dollar after 1985 following the Plaza Accord. It was considered, from a relational international contract viewpoint, as a rational compromise solution between two ideal-type extremes of international monetary regimes: the perfectly flexible and the perfectly fixed exchange rates.

The agreement was signed by Canada, France, West Germany, Japan, the United Kingdom, and the United States. The Italian government was invited to sign the agreement but declined.


The Plaza Accord was a joint–agreement signed on September 22, 1985, at the Plaza Hotel in New York City, between France, West Germany, Japan, the United Kingdom, and the United States, to depreciate the U.S. dollar in relation to the French franc, the German Deutsche Mark, the Japanese yen and the British Pound sterling by intervening in currency markets. The U.S. dollar depreciated significantly from the time of the agreement until it was replaced by the Louvre Accord in 1987. Some commentators believe the Plaza Accord contributed to the Japanese asset price bubble of the late 1980s.

The tight monetary policy of Federal Reserve's Chairman Paul Volcker and the expansionary fiscal policy of President Ronald Reagan's first term in 1981-84 pushed up long-term interest rates and attracted capital inflow, appreciating the dollar. The French government was strongly in favor of currency intervention to reduce it, but US administration officials such as Treasure Secretary Donald Regan and Under Secretary for Monetary Affairs Beryl Sprinkel opposed such plans, considering the strong dollar a vote of confidence in the US economy and supporting the concept of free market above all else. At the 1982 G7 Versailles Summit the US agreed to a request by the other members to a study of the effectiveness of foreign currency intervention, which resulted in the Jurgensen Report at the 1983 G7 Williamsburg Summit, but it wasn't as supportive of intervention as the other leaders had hoped. As the dollar's appreciation kept rising and the trade deficit grew even more, the second Reagan administration viewed currency intervention in a different light. In January 1985 James Baker became the new Treasure Secretary and Baker's aide Richard Darman became Deputy Secretary of the Treasury. David Mulford joined as the new Assistant Secretary for International Affairs.

From 1980 to 1985, the dollar had appreciated by about 50% against the Japanese yen, Deutsche Mark, French franc, and British pound, the currencies of the next four biggest economies at the time. In March 1985, just before the G7, the dollar reached its highest valuation ever against the British pound, a valuation which would remain untopped for over 30 years. This caused considerable difficulties for American industry but at first their lobbying was largely ignored by the government. The financial sector was able to profit from the rising dollar, and a depreciation would have run counter to the Reagan administration's plans for bringing down inflation. A broad alliance of manufacturers, service providers, and farmers responded by running an increasingly high-profile campaign asking for protection against foreign competition. Major players included grain exporters, the U.S. automotive industry, heavy American manufacturers like Caterpillar Inc., as well as high-tech companies including IBM and Motorola. By 1985, their campaign had acquired sufficient traction for Congress to begin considering passing protectionist laws. The negative prospect of trade restrictions spurred the White House to begin the negotiations that led to the Plaza Accord.

The devaluation was justified to reduce the U.S. current account deficit, which had reached 3.5% of the GDP, and to help the U.S. economy to emerge from a serious recession that began in the early 1980s. The U.S. Federal Reserve System under Paul Volcker had halted the stagflation crisis of the 1970s by raising interest rates. The increased interest rate sufficiently controlled domestic monetary policy and staved off inflation. By 1975, Nixon successfully convinced several OPEC countries to trade oil only in USD, and the US would in return, give them regional military support. This sudden infusion of international demand for dollars gave the USD the infusion it needed in the 1970s. However, a strong dollar is a double edged sword, inducing the Triffin dilemma, which on the one hand, gave more spending power to domestic consumers, companies, and to the US government, and on the other hand, hampered US exports until the value of the dollar re-equilibrated. The U.S. automobile industry was unable to recover.

While for the first two years the US deficit only worsened, it then began to turn around as the elasticities had risen enough that the quantity effects began to outweigh the valuation effect. The devaluation made U.S. exports cheaper to purchase for its trading partners, which in turn allegedly meant that other countries would buy more American-made goods and services. The Plaza Accord failed to help reduce the U.S.–Japan trade deficit, but it did reduce the U.S. deficit with other countries by making U.S. exports more competitive. And thus, the US Congress refrained from enacting protectionist trade barriers.

Joseph E. Gagnon describes the Plaza's result being more due to the message that was sent to the financial markets about policy intentions and the implied threat of further dollar sales than actual policies. Intervention was far more pronounced in the opposite direction following the 1987 Louvre Accord when the dollar's depreciation was decided to be halted.

The Plaza Accord was successful in reducing the U.S. trade deficit with Western European nations, but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan. This deficit was due to structural conditions that were insensitive to monetary policy, specifically trade conditions. The manufactured goods of the United States became more competitive in the exports market, though were still largely unable to succeed in the Japanese domestic market due to Japan's structural restrictions on imports. The Louvre Accord was signed in 1987 to halt the continuing decline of the U.S. dollar.

Following the subsequent 1987 Louvre Accord, there were few other interventions in the dollar's exchange rate such as by the first Clinton Administration in 1992-95. However, since then currency interventions have been few among the G7. The European Central Bank supported in 2000 then over-depreciated euro. The Bank of Japan intervened for the last time in 2011, with the cooperation of the US and others to dampen strong appreciation of the yen after the 2011 Tōhoku earthquake and tsunami. In 2013 the G7 members agreed to refrain from foreign exchange intervention. Since then the US administration has demanded stronger international policies against currency manipulation (to be differentiated from monetary stimulus).

The signing of the Plaza Accord was significant in that it reflected Japan's emergence as a real player in managing the international monetary system. However, the recessionary effects of the strengthened yen in Japan's economy created an incentive for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s. Some commentators blame the Plaza Accord for the Japanese asset price bubble, which progressed into a protracted period of deflation and low growth in Japan known as the Lost Decade, which has effects still heavily felt in modern Japan. Jeffrey Frankel disagrees on the timing, pointing out that between the 1985-86 years of appreciation of the yen and the 1990s recession, came the bubble years of 1987-89 when the exchange rate no longer pushed the yen up. The rising Deutsche Mark also didn't lead to an economic bubble or a recession in Germany.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.

sī vīs pācem, parā bellum

igitur quī dēsīderat pācem praeparet bellum    therefore, he who desires peace, let him prepare for war sī vīs pācem, parā bellum if you wan...