of the biggest problems in the City today is that so few people have worked in financial markets long enough to remember how things used to be just 25 years ago. This damaging lack of a collective memory helps to explain why so many investors remain so relaxed about the prospect of currency wars breaking out – or even support simplistic solutions which have previously been tried and seen to fail. I am therefore grateful to HSBC’s currency strategists, led by David Bloom, for reminding us that the last massive, globally coordinated intervention in the forex markets ended in tears.
I am referring, of course, to the Plaza Accord of 1985, a seminal intervention which saw selling of the greenback by all the top central banks and which ultimately had a massive impact on the global economy, albeit not the one its proponents were seeking. Given the widespread disappointment about the failure of discussions at the IMF this weekend to resolve anything – as if there were ever any hope of any consensus emerging – this ought to provide food for thought for all those who believe that “something must be done”.
There are many parallels with the current situation. The US was running a large trade and current account deficit in the early 1980s (about three per cent of GDP, the same as now), and US unemployment was unacceptably high (7.5 per cent, versus 9.6 per cent now). As ever, there were fears that US manufacturing jobs were being lost – in those days the enemy wasn’t China but rather Japan, partly because of the relative weakness of the yen, and Germany, because the Deutschemark was also thought to be too weak against the dollar. The agreement – struck at the Plaza Hotel in New York between the G5, made up of the US, the old West Germany, the UK, France and Japan – called for a “further orderly appreciation of the main non-dollar currencies against the dollar”, a decision which was followed by joint intervention.
In the two years following the agreement, the greenback fell by about 35 per cent on a trade-weighted basis and by over 40 per cent against the yen, HSBC calculates, a dramatic drop. This did ultimately cut the US current account deficit; US unemployment began to fall from 1987, though the reasons for this were much more complex. Remarkably, while Japan’s current account surplus dropped from 4.5 per cent of GDP in 1986 to 2.5 per cent in 1989, there was no significant decline in the US trade deficit with Japan, whose firms were somehow able to cope with the soaring yen. But there were real, disastrous unintended consequences from the Plaza Accords. A fearful Japan thought it could compensate for the soaring yen by easing monetary policy in 1985 (and again in 1987). But this merely helped fuel a demented Japanese equity and land bubble, with asset values shooting through the roof before the bust finally came in 1990, taking down the banking system and eventually turning that country from economic wunderkind to basket-case.
It is true that some currencies are hugely under-valued today: the Chinese renminbi by 17.7 per cent, the Malaysian ringgit and Hong Kong dollar by over 18 per cent and the Singapore dollar by 26.7 per cent, HSBC reports. Other countries – Indonesia, South Korea and Taiwan among them – also enjoy excessively cheap currencies. But the US should beware: any cure could easily turn out to be worse than the disease.