Most people believe that a stronger currency is good for an economy, but is it always a good news? Imagine you are an exporter from India, the exchange rate two years ago was Rs. 65 per dollar, would you want to export your goods then or today at the rate of Rs. 76 per dollar? Of course the latter. A weaker currency increases exports of a country, and as for imports, domestic residents rely more on domestic goods and avoid foreign goods as imports tend to get expensive. Balance of payments of a country which is measured by subtracting imports from exports also tends to increase. Well looks like, a weaker currency is indeed good to boost the economy.
Now let’s go back in time to the first half of 1980s, it was the time when the US Dollar appreciated by around 50% against the Yen, Deutsche Mark, French Franc and British Pound. So what’s wrong with dollar getting stronger? Stronger dollar started hurting US exports. American auto industry was struggling, farmers were struggling, the US manufacturing industry was under pressure and Americans were losing jobs. Current account deficits (imports exceeding exports) were reported at new historic highs every month. So here’s what happened, US economy’s strong growth accompanied with weaker domestic demand growth in Japan and Germany (both these countries were enjoying export benefits because of a weaker currency) lead to rising trade imbalances.
The person who was watching this happen was Ted Truman, who worked as an economist at the Federal Reserve bank, his job was to monitor the movement of dollar among other things. He didn’t believe that strengthening dollar would persist, he thought that the Dollar would eventually lose some value and that there was nothing that he or the Government could do about it. But there are always two ways of looking at the same problem, David Mulford, who was the under Secretary for International affairs in the US Treasury, thought that the rising dollar was nothing less than a threat to the US Economy. He had a secret (emphasis intended) plan, he would convince the leaders of the World’s biggest economies, France, the UK and Japan, to get together and secretly start selling the US Dollars. The idea was that, the increased supply of dollar would drive down its price down and make it weaker compared to other currencies. But here’s the catch, the world leaders were not so keen on the US telling them what to do. And of course there’s another question, would this idea to let their currency strengthen against the Dollar really help these countries? This would just mean that the stuff that they export would be more expensive to the Americans, and eventually lead to a decline of exports and hence current account deficit.
But the plan actually worked! David Mulford says in one of the interviews that, the other economies were fearful that the US would impose protectionist measures, which would eventually diminish their access to the US markets. This was a major threat to them. They were worried that the US would raise taxes on the goods coming into the US. And hence, David managed other economies to do what America wanted. He got each of them to commit. So on September 22, 1985 global central bankers and finance ministers decided to meet at the Plaza hotel to make Plaza accord a reality. So here’s what they were going to do, all of them at the same time would start selling the US dollars. Provided it remains a SECRET. And not just this, to promote global growth at the time when Japan and European nations were seeing negative growth of -7% along with huge trade surpluses, they also agreed to take several other measures. Germany agreed to cut tax rates, the UK agreed to limit public expenditure and transfer it to the private sector and Japan was to open its domestic and financial markets to foreign goods and services and also adopt a loose monetary policy to allow flexibility in its exchange rate.
So what made the Plaza Accord so unique? Well, it was the first time ever that the major economies of the world got together to what could possibly be a very costly intervention in the currency markets. But did the dollar depreciate just as much as was planned and anticipated? Turns out not. Just two years after the plaza accord was put into effect, the Dollar plummeted falling by almost 40%. This was way more than what David Mulford had ever expected. The relentless downward movement of dollar alarmed several players.
But this unprecedented movement of dollar according to Ted Truman, was not healthy for the economy. For one reason, depreciation would make imports more expensive and the higher prices could also lead to inflation. And what’s the worse, people started panicking with the dollar plummeting and began to lose confidence. The third problem was more global then just restrained to the US economy, Japan and other countries started saying that now their exports were more expensive relative to that of others, now that the Yen had appreciated by almost 40% against the dollar from 242 USD/JPY in September 1985 to around 153 in 1986. The plaza accord was not successful in its primary objective of alleviating trade deficit with Japan.
And so, on February 22, 1987 less than 2 years after the plaza accord decided to get together again and they signed the Louvre accord. This accord essentially was signed to undo everything that happened in the plaza accord. And this time instead of selling dollars, they were buying dollars. But was that successful indeed? Well for Japan it wasn’t, the Japanese felt the worst effects, in the long run. Looser monetary policy in Japan involved lower interest rates and ways to expand credit but cheap money policies also led to slower consumption rate at home, soaring land prices and also a creation of an asset bubble that would burst years later leading to what would be later called as the lost decade.
Dollar being considered the safe haven currency, is soaring again like the 1980s amid the uncertainty of Covid-19. Dollar index, which tracks the Dollar against major currencies is also at record highs. US Dollar continues to remain anticyclical and the sharp slowdown in growth for the first half of the year 2020 could help propel the dollar index to further new cycle highs in the coming month. In the month of March, GBP declined approximately 15% against the dollar and EUR declined by around 8%. So does this mean that there could be a possibility of another Plaza accord?
Very insightful