In 1985, the world’s major industrialized nations came together in an unprecedented collaboration known as the Plaza Accord. This agreement between the United States, Japan, West Germany, France and the United Kingdom was struck at New York’s Plaza Hotel with the goal of devaluing the U.S. dollar in relation to the Japanese yen and German Deutsche mark.
The Plaza Accord marked a major turning point in international finance and global economics. By depreciating the dollar, the governments hoped to help correct the large trade imbalance between the U.S. and Japan. This bold attempt at currency manipulation succeeded in boosting American exports and leveling the playing field. However, it also triggered a chain reaction of unexpected consequences.
Over the next decade, coordinated exchange rate intervention led to massive capital flows between nations. This influx of investment capital fueled stock market bubbles, shifts in trade balances, and the ascent of new economic powers. The effects of the Plaza Accord highlight both the importance and the challenge of international coordination around currency valuations.
Background of Slowing Economies and Trade Imbalances
In order to understand the context for the Plaza Accord, we must look back to the early 1980s. At this time, the world economy was struggling with slow growth, high unemployment and troubling imbalances.
Oil Crises of the 1970s
The 1970s had been a turbulent economic decade, largely due to two major oil crises. In 1973, Arab members of OPEC proclaimed an oil embargo on nations that had supported Israel in the Yom Kippur War. Oil prices quadrupled, shocking the economies of many industrialized nations. Just six years later, in 1979, an Islamic Revolution in Iran led to another doubling in the price of oil. These supply shocks wreaked havoc on major manufacturing economies like the United States, Japan and Germany.
Slow Productivity Growth
In the early 1980s, most advanced economies were hamstrung by declining productivity growth. In the decades after World War 2, productivity gains had been robust. But after the oil shocks, growth began to slow. New capital investments declined, and productivity stagnated. This slowdown limited economic growth and job creation.
Stubbornly High Inflation and Unemployment
Complicating matters was the strange combination of high inflation and high unemployment that first emerged in the 1970s. Traditionally, lower unemployment signaled a tight labor market which boosted wages and prices. But now, inflation seemed impervious to high jobless rates. With stagnant growth and “stagflation”, governments seemed to face a no-win situation.
Ballooning U.S. Budget Deficits
Various U.S. administrations had run large budget deficits, hoping to revive growth through tax cuts and spending programs. But the results were underwhelming. Deficits ballooned, but the economy remained sluggish. This flood of Treasury debt issuance pushed up interest rates. It also put downward pressure on the dollar, as foreigners bought fewer American bonds.
Deteriorating U.S. Trade Balance
Behind these domestic woes lurked a major deterioration in America’s trade balance. In 1971, President Nixon had unpegged the dollar from gold to halt a drain on U.S. reserves. Freed from constraint, the dollar’s value promptly fell. This made U.S. exports more competitive for a time. But over the course of the 1970s, the dollar rebounded while America’s trade position eroded once again.
A key piece of this puzzle was Japan. Still rebuilding from the war, Japan had nurtured its export-focused economy through the 50s and 60s. Now, Japanese automakers and electronics firms were beating American companies. “Made in Japan” became synonymous with quality manufacturing. Japan’s focus on exports led it to consistently run trade surpluses with the United States.
Calls for Protectionist Measures
With import competition harming U.S. industries, protectionist pressures arose. Political leaders blamed cheap Japanese imports for killing American manufacturing jobs. Unions joined the call for punitive tariffs to restrain Japanese exports. Although free trade economists preached patience, the lure of protectionism threatened to spark retaliation.
With these worrying trends in mind, the governments realized coordinated action could alleviate tensions and restore mutually beneficial trade. This realization paved the way for the Plaza Accord.
Negotiating the Plaza Accord
With economic worries mounting, finance ministers and central bankers from the U.S., Japan, West Germany, France, and the U.K. met in 1983 in Williamsburg, Virginia. At this G-5 summit, they discussed the disruptive volatility seen in currency markets. Exchange rates had diverged significantly from economic fundamentals. Major governments looked to push currencies back into alignment with their true values.
However, beyond goodwill gestures, little policy coordination occurred. Continued trade conflicts led President Reagan to propose import quotas on Japanese cars. But free trade advocates saw this as dangerous. With protectionist pressures still looming, the next G-5 summit was slated for September 1985.
Choosing a Location: The Plaza Hotel
For their third high-level economic summit, the powers chose a high-profile stage: New York’s Plaza Hotel. This luxurious landmark overlooking Central Park had hosted everyone from heads of state to movie stars. Business leaders and market observers closely watched the gathering of top economic officials at this storied venue.
The West German contingent checked in bearing an ambitious plan. They aimed to devalue the highly overvalued dollar against the German mark and Japanese yen. This surprise gambit reflected both economic and political motivations. West Germany sought to boost its exports and correct trade imbalances. But it also realized substantial dollar devaluation could help deter U.S. trade barriers against Japan.
Tough Negotiations
After German and American negotiators hammered out a draft plan, Japan pushed back forcefully. As the nation with the largest trade surplus, Japan faced the heaviest lift in cutting exports and expanding imports. Japanese authorities argued a dramatic 20% fall in the dollar would undermine its export-driven economy.
Intense haggling followed, with U.S. Treasury Secretary James Baker insisting Japan agree to intervene to lower the dollar’s value. Finally on September 22, 1985, the marathon talks concluded with an accord. The governments announced a plan to depreciate the U.S. dollar. This aimed to nudge exchange rates back toward equilibrium based on fundamentals.
Main Elements of the Agreement
In their brief joint statement, the G-5 nations outlined a bold yet delicate intervention plan. The central banks pledged action to drive dollars down and other currencies up. Let’s examine the key components of this coordinated effort.
Managed Depreciation of the U.S. Dollar
The main thrust involved marked devaluation of the U.S. dollar against the Japanese yen and German Deutsche mark. The governments aimed to cut the dollar’s value by as much as 20%. By making Japanese and German imports more expensive for Americans, a cheaper dollar would help reduce the U.S. current account deficit. This would provide relief for U.S. manufacturers.
Appreciation of the Yen and Mark
Correspondingly, the yen and mark would rise substantially against the dollar. This was accomplished by Japan and Germany using dollar reserves to buy their own currencies on forex markets. Stronger currencies would make their exports more expensive abroad. This would help balance out lopsided trade surpluses.
Stabilize Against Other Currencies
The agreement sought to prevent volatility versus other major currencies like pounds, francs and lira. While allowing dollars to fall versus marks and yen, the central banks would conduct operations as needed to maintain exchange rates with other currencies. This minimized disruption to global finance.
Coordinated Intervention
The governments stressed their shared commitment to coordinated intervention in currency markets. This collaboration aimed to guide exchange rates to new equilibrium levels consistent with more balanced global trade. They promised to take concrete actions rather than just pay lip service to currency realignment.
Monitoring Process
Finally, the accord set up an ongoing process for monitoring progress and adjusting the rebalancing plan. Teams of monetary officials agreed to converge twice annually to assess currency and trade flows. This ensured continued coordination.
Initial Impact on Currencies and Trade
In the months following the Plaza Accord, the dollar depreciated substantially as intended. By early 1988, the dollar had fallen about 50% versus the yen and 30% against the mark. Japan and Germany saw reduced trade surpluses, while U.S. exports picked up. The accord succeeded in catalyzing exchange rate adjustments and relieving trade pressures.
Currency Effects
The foreign exchange effects aligned with the policy goals. The U.S. Dollar Index versus major currencies fell sharply in 1985 and 1986. The greenback hit a multiyear low against the yen in 1987. However, later dollar weakness eventually drew concern from German and Japanese officials. Volatility emerged as central banks struggled to fine-tune currency movements.
Trade Flow Adjustments
As desired, the devalued dollar helped American manufacturers and farmers by making imports pricier. Japan and Germany saw surging exports slow. But for Japan, the steep 15% to 20% rise in the yen caused a severe slowdown. Japanese authorities were forced to cut interest rates to cushion the blow to economic growth.
Delayed U.S. Improvement
Despitecurrency shifts, U.S. trade deficits remained stubbornly high. American consumers continued buying foreign goods, offsetting some gains in exports. It took falling oil prices and eventual economic growth in the late 1980s before U.S. trade fundamentals improved significantly. The Plaza Accord’s effects took years to fully materialize.
Unintended Longer-Term Consequences
Looking beyond the immediate currency market impact, the Plaza Accord ushered in much more profound long-run changes. Let’s explore some of the farther-reaching consequences of this unprecedented policy action.
Japanese Asset Bubble
Seeking to mitigate the stronger yen, Japan slashed interest rates and eased monetary policy dramatically. This influx of cheap credit fueled speculation, especially in real estate. Japan’s Nikkei stock index tripled in the second half of the 1980s. Property values similarly skyrocketed. But these bubbles left Japan’s economy vulnerable. When the Bank of Japan hiked rates in 1989, Japanese markets finally cratered. The result was a prolonged period of economic stagnation known as Japan’s Lost Decade.
Growth of China
The sharply higher yen also catalyzed shifts in Asian manufacturing. Japanese firms moved production to cheaper countries, especially China. Conglomerates like Sony and Toyota built China factories and supply chains. This influx of investment capital and export manufacturing know-how helped transform China into a new industrial juggernaut. China’s GDP growth averaged over 10% in the 1990s, setting the stage for its rise.
German Reunification
By depressing the mark and boosting German exports, the accord created favorable conditions for West Germany. But in the early 1990s, reunification with post-Soviet East Germany placed huge strains on public finances. To pay integration costs, Germany was forced to run large budget deficits. The German economy slowed. But introducing the Euro helped boost German competitiveness.
U.S. Bubbles and Crises
The Plaza Accord contributed to problematic bubbles in America as well. With Japan investing abroad, huge capital inflows boosted U.S. asset prices. This helped inflate the late 1990s tech stock bubble. After it burst, easy Fed policy again drove speculative investment into housing markets, culminating in the 2008 subprime mortgage crisis. These traumatic U.S. boom-bust episodes have roots in the post-Plaza capital shifts.
Movement to Market-Set Exchange Rates
By demonstrating difficulties involved in rigging currency values, the Plaza Accord contributed to countries eventually shifting to market-determined exchange rates The wild swings and imbalances that followed this state intervention helped change attitudes. U.S. trade deficits and surpluses around the world eventually evened out more “naturally” through floating currencies.
Legacy and Significance
While the Plaza Accord didn’t fully achieve its initial aims, it left an immense legacy. This brief statement of policy coordination utterly transformed the global economic landscape. Beyond just exchange rates, the accord reshaped global capital flows, trade balances, and geopolitical weight.
Symbols of U.S.-Japanese Finance Rivalry
Many look back at the Plaza Accord as a defining episode in U.S.-Japan economic relations. It represented America’s effort to fight back against Japanese commercial ascendancy by weakening the yen. This interventionist approach departed sharply from free market orthodoxy. The later bubble and lost decade in Japan gave a competitive boost back to the U.S. But Japanese manufacturing would remain a key global player.
Model for Central Bank Cooperation
The Plaza Accord established an effective template for joint central bank action on exchange rates. Threatened by a rising Deutsche mark, G-7 nations again collaborated to weaken the dollar in the 1995 Louvre Accord. When the Euro’s strength turned excessive, authorities coordinated interventions. Global monetary officials now regularly confer on currency issues.
Sparked Globalization and Asian Growth
By catalyzing massive capital shifts, the Plaza Accord accelerated globalization and emerging markets development. Billions flowed into China, Southeast Asia, and Latin America seeking new opportunities. The accord marked a turning point where global integration began enabling poor countries to converge economically with the rich world.
Controversial Model of Currency Manipulation
Appraisals of the Plaza Accord remain split between praise and criticism. Supporters applaud its smoothing of trade imbalances and coordination success. But critics charge it represented reckless currency manipulation. They argue it led to damaging asset bubbles abroad and at home. Regardless of interpretation, the episode carries heavy historical significance.
Conclusion
Three decades after the world’s major finance ministers gathered at New York’s Plaza Hotel, the accord struck there continues to shape global affairs. This brief statement shook up currency markets, revamped trade, and propelled a new era of growth and connectivity.
The full legacy of the Plaza Accord remains open to debate. But its status as a transforming event is unquestionable. When it comes to understanding today’s integrated global economy and financial system, the landmark 1985 Plaza Accord is an essential starting point. It marked a rare moment when governments deliberately set out to redraw the world economic map – and succeeded more dramatically than they ever imagined.
