The two biggest events in the postwar history of currency exchange markets are the Nixon shock of August 1971 and the Plaza Accord of September 1985.
In the first case, then U.S. President Richard Nixon terminated the convertibility of the dollar to gold. An attempt by an international conference of finance ministers in December that year to rebuild the system by devaluating the dollar ended in failure, leading to the collapse of the Breton-Woods system, which had supported the currency exchange regime since the end of World War II.
The Plaza Accord of 1985 then sent the dollar into a decline that would last for the next 10 years, defying efforts by monetary authorities to stabilize exchange rates in the Louvre Accord of 1987. The dollar, which stood at around 240 yen just before the Plaza Accord, was being traded below 90 yen in April 1995.
Now, 20 years after the Plaza Accord, what has changed and what hasn’t?
The United States continues to post huge external deficits and is still troubled by one trade dispute after another. At the same time, the global economic environment has undergone substantial change as well.
For one thing, the main subjects of the United States’ trade disputes have shifted from Japan and West Germany to Japan and China, with the European Union’s surplus with the U.S. having declined over those two decades.
Meanwhile, a post-bubble hangover has hampered structural reforms in Japan, which still relies heavily on exports for growth. The Liberal Democratic Party’s landslide victory in the Sept. 11 Lower House election, however, suggests voters support Prime Minister Junichiro Koizumi’s reform efforts.
The second remarkable change is that the world economy is now less likely to face inflationary pressures because the end of the Cold War made inexpensive labor and land resources in China and the former Soviet-bloc countries available to the global market.
At the time of the Plaza Accord, the primary policy challenge was to deal with stagflation caused by the oil crises of the 1970s, and the policy of then U.S. Federal Reserve Chairman Paul Volcker, whose tightening of liquidity temporarily pushed short-term U.S. interest rates above 20 percent. The high rates attracted funds from around the world and, coupled with then President Ronald Reagan’s policy of a strong America and a strong dollar, inflated the dollar’s exchange rates beyond its real strength.
Today, interest rate gaps among the major currencies remain, especially with the Bank of Japan maintaining its zero-interest-rate policy. But that gap is much smaller than it was in the 1980s, and if the BOJ indeed decides to change tack, those gaps will narrow even further.
The third difference is that you also cannot expect to see the kind of policy coordination and concerted currency market intervention pursued by the then Group of Five key economies 20 years ago. The Plaza Accord was an effort by major industrialized nations to adjust foreign-exchange rates. The main subject of trade disputes today is China, which has barely liberalized its currency exchange and capital markets in international terms.
Despite the recent reform of China’s currency regime, the yuan’s exchange rate continues to be set by the Chinese government in a market that is restricted to only selected participants. As this author pointed out in a previous column (Japanese Perspectives, Aug. 15), the yuan’s exchange rate doesn’t reflect supply and demand in a free market, and the Chinese capital markets are still restricted even domestically.
Currency investors who skirted domestic restrictions in the U.S. and Japan created the Eurodollar and Euroyen markets, but no Euroyuan market has so far emerged. Thus the yuan is a currency for which trade has not been liberalized, and this symbolizes the current state of development of China’s economy.
We should also remind ourselves that China does not yet share the same appreciation of democracy that is common throughout the industrialized world.
The fourth factor is that the euro today plays the role of a key currency that can absorb public-sector funds from outside Europe. Furthermore, the 9/11 terrorist attacks of 2001 destroyed the myth of the U.S. being the world’s only safe haven.
Altogether, it is impossible today for the world’s major economies to solve their problems through policy coordination and concerted market intervention as they did in the 1980s. Trade friction with China must be dealt with in ways that suit the cause of each problem, while efforts should be made to urge China to reform its currency regime so the yuan’s exchange rate will be determined by the world’s major markets in a truer reflection of supply and demand.
In short, China is not yet qualified to join the ranks of the Group of Seven major economies.