Plaza Accord

Based on Wikipedia: Plaza Accord

In September 1985, five of the world's most powerful nations gathered at the Plaza Hotel in New York City to do something remarkable: they agreed to deliberately weaken the United States dollar. This wasn't a secret conspiracy or a hostile act. It was a coordinated intervention announced openly to the world, and it would reshape global economics for decades to come.

The Plaza Accord, as this agreement came to be known, stands as one of the most significant moments in modern monetary history. It demonstrated that when major economies work together, they can move currency markets. But it also serves as a cautionary tale about unintended consequences—consequences that some argue Japan is still living with today.

The Problem of the Mighty Dollar

To understand why five countries decided to gang up on the dollar, you need to understand just how strong it had become. Between 1980 and 1985, the dollar appreciated by roughly fifty percent against the currencies of America's major trading partners: Japan, West Germany, France, and the United Kingdom.

Why did this happen? Two factors converged. Paul Volcker, the chairman of the Federal Reserve, had waged an aggressive war against inflation by raising interest rates dramatically. Meanwhile, President Ronald Reagan's first-term policies created large budget deficits. High interest rates attracted foreign capital seeking better returns, and all that money flowing into America pushed the dollar higher and higher.

A strong currency sounds like a good thing. And in some ways it was. American consumers could buy imported goods cheaply. Foreign vacations became more affordable. The Reagan administration initially viewed the surging dollar as a vote of confidence in the American economy.

But there's a dark side to currency strength.

When your currency is expensive, your exports become expensive too. American farmers couldn't sell their grain abroad because it cost too much in local currencies. Caterpillar, the heavy equipment manufacturer, watched orders evaporate. The automotive industry, already struggling against Japanese competition, found itself at an even greater disadvantage. Even technology giants like IBM and Motorola felt the squeeze.

By March 1985, the dollar reached its highest valuation ever against the British pound—a record that would stand for more than thirty years. American industry was hurting badly, and manufacturers who had initially been ignored by Washington began making noise that couldn't be dismissed.

The Road to the Plaza

The French had been pushing for currency intervention for years. They believed governments should actively manage exchange rates rather than leaving everything to markets. But key figures in Reagan's first-term Treasury Department were ideological free-market advocates. Donald Regan, the Treasury Secretary, and Beryl Sprinkel, his Under Secretary for Monetary Affairs, opposed intervention on principle.

This philosophical resistance began crumbling under practical pressure. American manufacturers, service companies, and farmers formed a powerful coalition demanding protection from foreign competition. Their lobbying campaign gained such momentum that Congress started seriously considering protectionist legislation—tariffs and trade barriers that would shield American companies from imports.

This prospect alarmed the Reagan administration. Protectionism would invite retaliation from trading partners and could spiral into a trade war. Currency intervention suddenly looked like the lesser evil.

The personnel change mattered too. In January 1985, James Baker became Treasury Secretary, replacing Donald Regan. Baker was a pragmatist, not an ideologue. He brought Richard Darman as his deputy and David Mulford as Assistant Secretary for International Affairs. This new team was willing to consider tools their predecessors had rejected.

Preparatory work began in earnest. A small amount of intervention was quietly agreed upon at a January meeting of the Group of Five—the finance ministers of the United States, Japan, West Germany, France, and the United Kingdom. The Germans sold dollars heavily in February and March. By April, the Americans signaled openness to a major summit on international monetary reform.

The Plaza Meeting

On September 22, 1985, finance ministers and central bank governors from the five nations gathered at New York's Plaza Hotel. The meeting itself was brief, but its announcement electrified financial markets.

The communiqué was carefully worded. The ministers agreed that "some further orderly appreciation of the non-dollar currencies is desirable" and declared they "stand ready to cooperate more closely to encourage this when to do so would be helpful."

Translation: we want the dollar to go down, and we're going to make it happen.

The following Monday, when news of the meeting became public, the dollar dropped four percent against other major currencies in a single day. That was just the beginning. The depreciation continued for nearly two years until the Louvre Accord of 1987 called a halt to the dollar's decline.

What's fascinating about the Plaza Accord is that relatively little actual intervention was required. Joseph Gagnon, an economist who has studied the episode, argues that the announcement itself did most of the work. Financial markets understood that these five governments were committed to a weaker dollar and adjusted their positions accordingly. The implied threat of sustained intervention was enough to move exchange rates.

Did It Work?

The answer depends on what you think the Accord was supposed to accomplish.

The immediate goal was reducing America's trade deficit, which had swollen to three and a half percent of gross domestic product. Here the results were mixed and somewhat counterintuitive.

For the first two years after the Accord, the trade deficit actually got worse. This seems paradoxical—shouldn't a cheaper dollar mean fewer imports and more exports? The explanation lies in what economists call the J-curve effect. When your currency falls, imports immediately become more expensive in dollar terms. It takes time for the quantity of imports to decline and for export volumes to rise. In the short run, you're paying more for roughly the same basket of goods.

Eventually, the quantity effects caught up with the price effects. The deficit began shrinking as Americans bought fewer imported goods and foreigners bought more American products.

The Accord clearly succeeded in reducing America's trade deficit with Western Europe. American manufactured goods became genuinely competitive again in those markets.

But Japan was another story. The trade deficit with Japan barely budged. This wasn't about currency at all—it was about structural barriers. Japan's economy had evolved with various restrictions on imports that had nothing to do with exchange rates. Making American goods cheaper didn't matter if Japanese distribution systems effectively excluded them.

Still, the Accord achieved one crucial political objective. By demonstrating that the administration was taking action on trade imbalances, it defused congressional pressure for protectionist legislation. The threat of trade barriers receded.

Japan's Bubble and the Lost Decades

The Plaza Accord had consequences that extended far beyond trade balances. Some economists blame it for one of the most spectacular economic disasters of the twentieth century: Japan's asset price bubble and subsequent "Lost Decade."

Here's the argument. As the yen appreciated sharply after the Accord, Japan's export-dependent economy faced recessionary pressure. The Japanese government responded with aggressive monetary and fiscal stimulus to offset the currency headwind. Interest rates fell. Credit became cheap and abundant.

That money had to go somewhere. Much of it flowed into real estate and stocks. Japanese asset prices soared to absurd heights. At the peak of the bubble in 1989, the grounds of the Imperial Palace in Tokyo were supposedly worth more than all the real estate in California. Japanese companies bought trophy properties around the world, from Rockefeller Center to Pebble Beach golf course.

When the bubble burst in 1990, Japan entered a prolonged period of deflation, stagnation, and economic malaise that lasted not one decade but arguably two or three. The country that seemed poised to overtake America as the world's economic superpower in the 1980s spent the following decades struggling with zombie banks, demographic decline, and persistent deflation.

Did the Plaza Accord cause all this? The connection is disputed. Jeffrey Frankel, a Harvard economist, points out a timing problem. The yen appreciation occurred in 1985 and 1986. The bubble years were 1987 through 1989, when the yen was no longer rising. The recession came in the 1990s. If the Plaza Accord caused the bubble, why didn't the effect show up immediately?

Richard Werner, another economist, argues that external pressure like the Accord cannot fully explain the Bank of Japan's policies. Domestic factors and internal decisions at the central bank played crucial roles that had little to do with American pressure.

The truth probably lies somewhere in between. The Plaza Accord created conditions that enabled the bubble without directly causing it. Japanese policymakers made their own choices about how to respond, and those choices proved disastrous.

Notably, West Germany faced similar currency appreciation after the Plaza Accord. The Deutsche Mark rose just as the yen did. Yet Germany experienced no comparable bubble and no lost decade. Different policy responses led to different outcomes.

The End of an Era

The dollar's depreciation continued until 1987, when the major economies decided things had gone far enough. The Louvre Accord, signed that February, marked a shift to stabilizing currencies rather than pushing the dollar lower. Intervention under the Louvre Accord was actually more aggressive than under the Plaza, but in the opposite direction—now the goal was to prevent further dollar weakness.

Since the Louvre Accord, coordinated currency intervention among major economies has become rare. The first Clinton administration intervened in the early 1990s. The European Central Bank supported the struggling euro in 2000. The Bank of Japan intervened in 2011 after the devastating Tohoku earthquake and tsunami created pressure on the yen. But these episodes have been exceptions.

In 2013, the Group of Seven countries formally agreed to refrain from foreign exchange intervention. The consensus shifted toward letting markets determine exchange rates, though governments still watch currency movements closely and occasionally jawbone markets with verbal interventions.

Lessons and Legacy

The Plaza Accord demonstrated that coordinated action by major economies can move markets. When the United States, Japan, Germany, France, and the United Kingdom speak with one voice about currency values, investors listen.

It also showed that currency policy has limits. Changing exchange rates cannot overcome structural trade barriers. Making American goods cheaper didn't open Japan's markets. Only domestic reform in Japan could do that.

Perhaps the most important lesson involves unintended consequences. Policies designed to solve one problem can create others. The stimulus Japan deployed to offset yen appreciation contributed to an asset bubble that haunted the country for decades. Currency intervention is a powerful tool, but powerful tools can do powerful damage when wielded carelessly.

The Accord also marked Japan's emergence as a genuine partner in managing the international monetary system. For the first time, Japan sat at the table as an equal, not as a country being managed by others. This was recognition of Japan's economic importance—even if what followed suggested that importance came with vulnerabilities the Japanese had not fully appreciated.

Today, as countries contemplate responses to trade imbalances and currency pressures, the Plaza Accord remains a reference point. It showed what's possible when major economies cooperate. It also showed what can go wrong when the ripple effects of intervention spread in unexpected directions.

The five finance ministers who gathered at the Plaza Hotel in September 1985 solved their immediate problem. They weakened the dollar, eased pressure on American industry, and avoided a protectionist spiral. Whether the price was worth paying—whether the bargain included seeds of Japan's lost decades—remains debated by economists forty years later.