Could America and its allies club together to weaken the dollar?

Many of America’s allies would support an attempt to hammer the greenback. Photo: Pixabay
Many of America’s allies would support an attempt to hammer the greenback. Photo: Pixabay

Summary

  • China would not be happy

The Plaza Hotel has New York glamour in spades. Sitting at a corner of Central Park, it was the setting for “Home Alone 2", a film that came out in 1992 in which a child finds himself lost in the metropolis. He takes up residence in one of the hotel’s suites, thanks to his father’s credit card, and briefly lives a life of luxury. Donald Trump, the hotel’s owner at the time, has a walk-on part, which was the outcome of a hard bargain. According to the film’s director, he demanded to appear as a condition for giving the filmmakers access to the hotel. This was not the first deal in which the venue had played a part. Seven years earlier it hosted negotiators for the Plaza Accord, which was agreed on by America, Britain, France, Japan and West Germany, and aimed for a depreciation of the dollar against the yen and the Deutschmark.

Echoes of the period can be heard today. In the mid-1980s America was booming. Ronald Reagan’s tax cuts had led to a wide fiscal deficit and the Federal Reserve had raised interest rates to bring inflation to heel. As a consequence, the dollar soared. American policymakers worried about a loss of competitiveness to an up-and-coming Asian economy (Japan then, China today). The Plaza Accord was designed to address what officials saw as the persistent mispricing of the dollar. Robert Lighthizer, Mr Trump’s trade adviser, has mulled a repeat. The accord set a precedent for “significant negotiation between America’s allies to address unfair global practices", he wrote in “No Trade is Free", a book published last year. Mr Trump’s team is reportedly considering options to devalue the dollar if the former president returns to office.

Many of America’s allies would support an attempt to hammer the greenback. Asian officials worry about a strong dollar raising the cost of imported commodities, many of which are priced in the currency, as well as the expense for exporters who finance trade in it. In April Japan and South Korea released a statement along with the American Treasury, acknowledging “serious concerns....about the recent sharp depreciation of the Japanese yen and the Korean won". More recently, Japan has seemingly spent tens of billions of dollars boosting its currency.

Could the Plaza Accord be a blueprint for a new era of collaboration? Economists are wary of currency intervention. In the presence of monetary policy that targets inflation, the textbook model says it should have little impact on the exchange rate. Differences in interest rates, perceptions of risk, and anticipated inflation and growth are what should drive capital flows between countries. A central bank that wants to stand in the way of the market must subordinate its inflation goal to defending the currency, lest it burn through its foreign-exchange reserves.

The Plaza Accord, though, represented a best case for intervention, as it was co-ordinated between several central banks and pushed markets in a direction in which they were already heading. The dollar had peaked in February 1985—more than half a year before the meeting at the Plaza Hotel. Jeffrey Frankel of Harvard University attributes its turnaround to the appointment of James Baker as treasury secretary that month. He mentioned the problem of the strong currency at his appointment hearing. The agreement at the Plaza Hotel was the capstone to fiscal- and monetary-policy changes already under way, providing a confirmation for currency traders that officials had shifted their focus. Today, by contrast, policy looks fixed. Persistent inflation has led the Federal Reserve to push back interest-rate cuts. Although shrinking America’s fiscal deficit would help address both inflation and the strong dollar, neither presidential candidate shows much keenness for the rectitude that would be required.

Perhaps Mr Trump could employ the tactic he used when securing a cameo in “Home Alone 2": swapping access for a favour. Indeed, Mr Lighthizer has advocated something along these lines, suggesting that America could threaten to shut competitors out of its domestic market, much as it did when securing the Plaza Accord. Back then a growing trade deficit with Japan prompted a resurgence of American protectionism among the country’s politicians. One congressman remarked that “the Smoot-Hawley tariff itself would have passed overwhelmingly had it come to the floor", referring to an infamous Depression-era tariff increase that set off a wave of retribution around the world. Bringing about a stronger yen through co-operation was seen as an alternative to tariffs on Japan: both would weaken the country’s exporters while supposedly strengthening America’s.

The art of the deal

It is hard to imagine a similar agreement with China today. America sees the country not just as an economic competitor, as it did Japan, but as a geopolitical threat. Tariffs are already high and a range of Chinese goods, from electric vehicles to social-media apps, face restrictions in American markets, often on the grounds of national security rather than economic protectionism.

Suppose, however, that America got its budget under control, reducing inflationary pressure as well as the need for counterbalancing inflows of foreign capital. Then it might be able to work with Asian allies, and persuade European ones, to strengthen their currencies against the dollar. Such a united front could put China in a difficult situation. Previously the country has responded to tariffs by devaluing the yuan. Research by Goldman Sachs, a bank, suggests that the Chinese government weakened the yuan by 0.7% for every increase in implied tariff revenue for America of $10bn during the 2018-19 trade war. If the dollar was already falling, the Chinese government would have to choose between accepting the effects of the tariffs or starting a currency war that it might lose. Giving his rival such a dilemma would be an even better outcome for Mr Trump than a big-screen cameo.

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© 2024, The Economist Newspaper Limited. All rights reserved. From The Economist, published under licence. The original content can be found on www.economist.com

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