Fixing the dollar: Why an international accord won’t work
The days of international cooperation among central bankers to rebalance the currency market are over.
In 1985, finance ministers of what were then the world’s five biggest economies gathered at New York City’s Plaza Hotel, where they signed the Plaza Accord, an agreement on the orderly devaluation of the U.S. dollar against the Japanese yen and the German mark. The accord has generally been hailed a success as far as getting the varying countries to agree where the value of the dollar should fall: The U.S., Japan, West Germany, France and the United Kingdom basically promised to tweak their currency markets as necessary, helping the U.S. narrow its trade deficit and recover from a recession that started in the early 1980s.
The agreement worked almost a little too well. About two years later, the greenback was in serious decline, falling by 54% against the yen and the mark. So the economies reached another deal called the 1987 Louvre Accord, which helped appreciate and stabilize the dollar.
As today’s debate over currency valuations intensifies, world leaders can only dream of that kind of swift international cooperation.
The rise of currencies from the Japanese yen to the Australian dollar have sparked serious concerns, potentially threatening to interrupt economic recoveries — currency strength tends to make exports less competitive. Though the U.S. dollar strengthened some against the euro on Tuesday, it has generally been declining in recent weeks, especially since some Federal Reserve members have hinted at attempting to boost the economy with fresh money. All the while, policymakers have grown increasingly frustrated by the Chinese government’s unwillingness to appreciate its currency, the yuan, at a rate they see fit.
There’s no doubt some kind of international cooperation will need to emerge, but it won’t likely be modeled on the Plaza Accord. Last week’s annual meetings of the International Monetary Fund proved just how touchy a topic the state of the world’s currencies have become. The gathering arguably didn’t produce much of an outcome and it’s likely that President Obama and leaders of the Group of 20 industrialized nations will take up issues over China’s yuan when they gather next month in Seoul, South Korea.
As currency tensions develop, here are three factors standing in the way of an orderly fix with international cooperation:
The height of the global financial crisis has passed
During the tumultuous periods of the financial crisis, policymakers appeared to have a pretty easy time coordinating plans to offset impacts of the global credit crunch. Governments and central bankers beefed up fiscal spending and slashed interest rates, keeping their economies from altogether collapsing as some of the world’s largest banks including Lehman Brothers went under. It’s not that global policy coordination doesn’t exist today, but it will be harder to achieve as the crisis has eased and central bankers are more focused on their own economic recoveries.
“We’re entering into a very complicated phase in which you will see more friction and confrontation,” says Thomas Klein- Brockhoff, policy programs senior director of the U.S. German Marshall Fund, a Washington DC-based public policy organization that promotes cooperation between North America and Europe.
What has transpired is an Asian recovery fueled by China and a European recovery driven by Germany. And as the U.S. struggles to recover from the longest recession since the Great Depression, Congress has ramped up pressures to get China’s government to appreciate its currencies as unemployment hovers at an uncomfortably high 9.6%. The Peterson Institute for International Economics estimates that if China’s exchange rate rose by 20% to 25% over the next two to three years, appreciation of the yuan would reduce China’s trade surplus by $350 billion to $500 billion and the U.S. trade deficit by $50 billion to $120 billion. It could also create about half a million U.S. jobs mainly in manufacturing over the next few years.
With piqued interest among world many world leaders over what’s going on at home, it’s easy to see why coming up with a unified policy prescription becomes much tougher. The currency debate might just have to rise to global crisis mode before any real coordination emerges.
Emerging economies matter
The Plaza Accord dealt with a single currency issue, which made it a much less complex problem to tackle compared with the currency tensions world leaders face today, says Edwin Truman of the Peterson Institute and former assistant secretary of the U.S. Treasury for International Affairs.
Though it’s clear the current debate focuses largely on pressures to significantly appreciate China’s yuan, it’s not the only currency that is viewed as undervalued. Some have argued that many of the East Asian currencies, such as the Hong Kong dollar, Singapore dollar and the Taiwan dollar need to appreciate, which makes any kind of unified agreement all the more complex.
Adding to the matter is the growing influence of emerging economies over economic policy. Unlike the days of the Plaza Accord, the rapid rise of economies such as China, India and Brazil have given them more say over how the global marketplace should run. Take, for instance, the IMF — it’s considering giving more board representation to emerging economies. This could mean Europe loses some of its positions on the board.
Hard to wag fingers when you might be guilty yourself
U.S. officials, in particular, have argued time and again that China keeps the yuan artificially low, which in turn, gives the country an unfair advantage of selling goods more cheaply abroad. However, some say America might just be as guilty for embarking on policies that weaken the U.S. dollar. In fact, in the six or so weeks that the Federal Reserve started talking about further easing monetary policy, the greenback has declined 7% against a basket of major currencies.
This is probably be a relatively minor issue. But the point is any unified plan will involve some give and take. And that becomes increasingly difficult when more countries and more currencies count in the great debate.