The historic 1985 Plaza Accords, signed at the Plaza Hotel in New York city, was a pro growth agreement signed by what was then known as the G-5 nations, West Germany, France, United States, Japan and the United Kingdom to force the United States to devalue its currency due to a current account deficit approaching an estimated 3 percent of GDP. (Paragraph 6, Plaza Accords).
More importantly, the European nations and Japan were experiencing enormous current account surpluses as well as negative GDP growth that threatened not only external trade and GDP growth in their home nations but protectionist measures to protect these gains were looming, especially in the United States. Add the fact that developing nations were in debt and not able to participate in positive trade or positive growth in their home nations, the United States was forced to realign the exchange rate system due to present imbalances and to promote growth around the world at the expense of its own nation.
The Plaza Accords was a growth transfer policy for Europe and Japan that was wholly detrimental to the United States..
The United States experienced 3 percent GDP growth during 1983 and 1984 with a current account deficit approaching an estimated 3- 3.5 percent of GDP while European nations saw a negative GDP growth of -0.7 percent with huge trade surpluses. Same for Japan. Trade deficits in general require foreign financing. For the United States during the early to mid 80’s, Japan and West Germany were buying United States bonds, notes and Bills from their surpluses to finance our current deficits at the expense of their own economies.
It was a matter of time before protectionist policies entered this equation that would not only hurt United States growth at home but force trade wars that would derail the entire system of trade for all nations.
During this period not only was inflation the lowest it has been in 20 years for all nations but European nations and Japan were investing in their own economies to promote growth. With low inflation and low interest rates, the repayment of debt would be accomplished quite easily. The only aspect missing from these equations was an adjustment in exchange rates rather than an overhaul of the present system.
So the world cooperated for the first time by agreeing to revalue the exchange rate system over a two year period by each nation’s central bank intervening in the currency markets.Target rates were agreed to. The United States experienced about a 50 percent decline in their currency while West Germany, France, the UK and Japan saw 50 percent appreciations. The Japanese Yen in September 1985 went from 242 USD/JPY, Yens to the dollar to 153 in 1986, a doubling of value.
By 1988, USD/JPY exchange rate was 120. Same with the German Deutsch Mark, French Franc and British Pound. These revaluations would naturally benefit developing nations such as Korea, Thailand and leading South American nations like Brazil because trade would again flow.
What gave the Plaza Accords its historic importance was a multitude of firsts. First time central bankers agreed to intervene in the currency markets, first time the world set target rates, first time for globalization of economies and first time each nation agreed to adjust their own economies, sovereignty was exchanged for globalization. For example, Germany agreed to tax cuts, the UK agreed to reduce its public expenditure and transfer monies to the private sector while Japan agreed to open their markets to trade, liberalize their internal markets and manage their economy by a true Yen exchange rate. All agreed to increase employment. The United States bearing the brunt of growth only agreed to devalue their currency. The cooperative aspects of the Plaza Accords was the most important first.
What the Plaza Accords meant for the United States was a devalued currency. This means United States manufacturers would again become profitable due to favorable exchange rates abroad, an export regimen that became quite profitable.
A high US dollar means American producers can’t compete at home with cheap imports coming from Japan and European nations because those imports are much cheaper than what American manufacturers can sell according to their profitability arrangements. An undervalued currency means those same imports would experience higher prices in the United States due to unfavorable exchange rates.
What a high dollar means for the United States is low inflation and low interest rates that benefit consumers because they have enough dollars to far exceed prices paid for goods. What the United States agreed to was a transfer of a part of their GDP to Europe and Japan so their economies would experience growth again. And all accomplished without fiscal stimulus, only an adjustment of exchange rates. What is much understood in the modern day are the harsh effects such devaluations may have on an economy.
The Japanese felt the worst effects in the longer run of its signing of the Plaza Accords. Cheaper money for the Japanese meant easier access to money along with the Bank of Japan’s adoption of cheap money policies such as a lower interest rate, a credit expansion and Japanese companies that moved offshore. The Japanese would later become the world’s leading creditor nation of the world. But cheap money policies would later create a slower consumption rate at home, rising land prices and the creation of an asset bubble that would burst years later that led to the period for Japan known as the lost decade. Japan’s recovery today from its lost decade is still very questionable due to the price of its currency. This maybe the reason why currency prices today target inflation as a means to gauge growth policies rather than some arbitrary target as was set with the Plaza Accords.
October 2009 Brian Twomey
Brian Twomey is a currency trader and adjunct professor of Political Science at Gardner-Webb University