Thirty seven years ago, on 22nd September of 1985, the representatives from the now defunct G-5 met at Plaza Hotel, New York to discuss one of the most remarkable currency manipulation plans. On that afternoon, the US, France, Germany, UK, and Japan signed the Plaza Accord to weaken the US dollar to help the US reduce its burgeoning trade deficit.
As part of the accord, the US agreed to cut its fiscal deficit materially; while Germany and Japan consented to boost their domestic demand by cutting taxes. All parties agreed to actively “manage” their currency markets to “correct” their current account imbalances.
In backdrop to the Plaza Accord, the US Dollar had appreciated about 48% during 1980-1985, primarily induced by the sharp hikes in the policy rates by the US Federal Reserve, led by the Paul Volcker; pressurizing the US manufacturing by making (i) imports from Japan and Germany more competitive and (ii) exports to other countries less competitive. This was the time when US manufacturing giants like IBM and Caterpillar were facing severe stress and lobbying the US Congress for relief.
The US Dollar (USD) depreciated over 25% against Japanese Yen (JPY) and German Mark (DEM) in the two years following the Plaza Accord. The plan worked with limited success but not without material collateral damage. The US-Japan trade sustained as Japanese automobile and Electronic products continued to overwhelm the US consumers. US-Germany trade imbalance corrected materially. A stronger JPY however resulted in severe deflationary conditions in the Japanese economy, resulting in the famous “lost decade”.
Paul Volcker retirement from US Federal Reserve and appointment of Alan Greenspan was heralded by Black Monday, 19th October 1987. The stock markets crashed the world over and the limitation of the Plaza Accord stood exposed. The era of “Greenspan Put” that started in 1987 has continued till recently, with few short interspersed breaks; though the nomenclatures are now more generic like “Fed Put”, “ECB Put”, “BoJ Put” etc.
The current situation in the US is no different from the early 1980s. Inflation is persistently high. Rates are rising. The USD is strengthening. The trade deficit is now with China, instead of Germany and Japan then. The growth has slowed down materially. But the stock market implied volatility is impudently low. The only plausible explanation for this in my view is that the markets have strong belief in the central bankers’ put. The markets appeared assured by the reckless support extended by the central bankers post Lehman Collapse and in the wake of Covid pandemic. The belief that a “black Monday will not be repeated” is too strong at this point in time.
In this context, the latest presentation of Fidelity International on “2023 Investment Outlook” makes an interesting reading. Outlining one of the three key themes for 2023, the presentation, inter alia, highlights the following:
· Interest rate differentials have driven the dollar ever higher, creating headwinds for countries dependent on trade, with large external debt burdens, and/or maintaining a currency peg. Vulnerability is highest among emerging markets.
· We see chances for a Plaza 2.0 type global accord on controlling the dollar as low in the absence of a full-blown currency crisis. In the meantime, central banks including the BOJ and HKMA must ramp up efforts to defend currencies.
