The Dollar: No Devaluation Déjà Vu


By Brian Bremner In these times of huge global trade imbalances and the U.S. and China bickering over exchange rates, it's a shame that the 20th anniversary of the fabled Plaza currency accord didn't get more notice.

Back on Sept. 22, 1985, the Group of Five nations (the U.S., Japan, Britain, West Germany, and France) agreed to devalue the U.S. dollar vs. the Japanese yen and German deutschemark though a series of currency interventions. A year later, the dollar had depreciated by about 50% in one of the biggest and fastest currency realignments in post-war history. This move would not only revive U.S. competitiveness in exports but also contribute to a massive speculative bubble in Japan.

SOARING TRADE SURPLUS. What's the relevance of the Plaza Accord to today's financial markets? It's greater than you think.

In 1985, much like today, there were huge worries about massive budget and current-account deficits in the U.S. In 1985, the U.S. current-account deficit was about 3.5% of gross domestic product. Today, it's about 6%. Inside the U.S., there was great anxiety about the economic ascendancy of an Asia economy -- namely, Japan. Today, it's China that has the U.S. worried. Also in 1985, U.S. trade hawks maintained that Japan used a dramatically undervalued yen to raid foreign markets. Ditto now for China and the yuan.

Indeed, the U.S. is sending Federal Reserve Chairman Alan Greenspan and Treasury Secretary John Snow to Beijing this week to urge Chinese monetary authorities to let the yuan appreciate against the dollar. Most economists expect China's global trade surplus to jump more than threefold, to greater than $100 billion by yearend. Its bilateral trade surplus with the U.S. could finish at around $200 billion.

FAST ONE. Is the world economy heading for Plaza 2: The Sequel? Probably not, for it's doubtful the Bush Administration could pull off the sweet deal its predecessors in the Reagan era managed. In Japan, and I suspect in China, too, there's a feeling that the U.S. and other Western economies pulled a fast one 20 years ago. Isao Kubota, who served as a senior official inside Japan's Finance Ministry in the mid-'80s, points out that that the architects of the Plaza deal were originally talking about a much more modest depreciation of the dollar -- some 10% or so.

Of course, it was all shrouded in secrecy. The official accord only said "orderly appreciation of the main non-dollar currencies against the [U.S.] dollar was desirable." And it's true that the greenback probably did warrant a modest correction of sorts. Instead, the currency swooned and the yen soared, which set off an incredible shock to the Japanese economy.

The Japanese never signed on to a 50% jump in their currency. And when then-Japanese Finance Minister Noburo Takeshita complained about the dramatic currency swing during an international summit meeting in 1986 in Tokyo, he was basically ignored by the U.S., Britain, and other Western countries. "It was a great worry for us to have that kind of appreciation," says Kubota, who now is an economics professor at Japan's Teikyo University and chairman of Lone Star Japan Acquisitions.

COMPOUNDED PROBLEMS. Still, and Kubota and others concede this: The Japanese then compounded the impact of the currency shock by keeping monetary and fiscal policies loose in the 1980s. Real estate prices soared in major Japanese cities. Corporate Japan and Tokyo money center banks used a supercharged currency to buy U.S. real estate assets like Pebble Beach and Rockefeller Center at what turned out to be ludicrously high prices. The bubble popped in 1990, and more than a decade of economic stagnation ensued in Japan. Only in the last couple of years has Japan finally emerged from the economic swamp.

That said, when the U.S. lectures other economies about letting the markets dictate the true value of their currency, other players have reason to be suspicious. It's a convenient stance for the U.S. to take. Most of the world's global trade is denominated in dollars. And that frees a lot of major U.S. companies from huge worries about exchange risk when the dollar gyrates against other currencies.

Also, the U.S. budget deficits are problems of America's own making -- namely, the Bush Administration's decision to cut taxes early in its first term and to shoulder the costs of its invasions into Afghanistan and Iraq without undoing the those cuts or raising taxes.

WHY THE HYSTERIA? As for China, my hunch is that Chinese President Hu Jintao's government has absolutely no intention of repeating the Japanese experience. Its economy is far less developed than Japan's was in the mid-'80s, and it needs fast-track economic growth to absorb some 10 million new workers a year.

Also, some of China's biggest exporters are actually foreign companies, such as Nokia (NOK) and Motorola (MOT), that use China as a final assembly base and ship out products to other markets. Some in Beijing understandably ask: Why all the hysteria about Chinese trade data?

So where does that leave us? Right now, the U.S. debt machine continues to grow more powerful with little consequence to either the U.S. economy or long-term interest rates. That's because both China and Japan continue to use their surplus savings and current-account surpluses to buy U.S. Treasury bonds.

SKEPTICAL RECEPTION. But what if the U.S. gets into trouble? What if interest rates soar to keep attracting foreign money? What if the U.S. turns to other economies and their Finance Ministers for some sort of coordinated currency regime to bail it out?

Let's hope it doesn't come to that because a U.S. economy in crisis would be bad for everyone. But this much is clear: The U.S. would likely face far more skeptical trading partners than it did back in the mid-1980s. The Plaza Accord may seem like ancient history to most folks -- but not to those who count most. The Finance Ministries and central banks of Japan and China have very long memories.

Bremner is BusinessWeek's Asia Regional Editor based in Hong Kong


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