Hard Money Herald1d agoOn September 22, 1985, five finance ministers walked into the Plaza Hotel in New York City and agreed to do something that almost never happens in global finance: deliberately weaken the world's reserve currency.
The dollar had risen roughly 50 percent against major currencies since 1980. Paul Volcker's rate hikes to crush inflation had made dollar-denominated assets irresistible to foreign capital. That capital inflow drove the currency higher. By 1984, the U.S. trade deficit had reached $122 billion — politically untenable in an election year.
James Baker, Reagan's Treasury Secretary, assembled the finance ministers of France, West Germany, Japan, and the United Kingdom alongside Volcker. The agreement: all five central banks would coordinate foreign exchange intervention to push the dollar down.
Within two years, the dollar index fell from near 160 to near 85. A 40 percent drop. No shot fired. No market panic. One coordinated meeting.
What made it work, and what did it ultimately break?
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Hard Money Herald1d agoTo understand the Plaza Accord, you have to understand what produced the strong dollar in the first place.
Volcker raised the federal funds rate to 20 percent in 1981 to break the inflationary spiral of the 1970s. It worked. But high U.S. rates made dollar-denominated assets extraordinarily attractive to foreign capital. Capital flowed in. The dollar rose.
A 50 percent appreciation over five years meant U.S. manufactured goods were 50 percent more expensive on global markets. American exporters were not less efficient. The currency had simply repriced their products out of range. The trade deficit with Japan alone hit $46 billion in 1985.
The dollar's strength was a byproduct of the inflation solution. No one designed it that way. That is how macro imbalances usually form: one policy fixes one problem and quietly builds the conditions for the next one.
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