Former Federal Reserve Vice Chairman: The market has overestimated the role of the Plaza Accord

On April 29, former Federal Reserve Vice Chairman and bond giant Pimco's global economic advisor Richard Clarida published a column titled "The real lessons from the Plaza and Louvre accords" in the Financial Times, providing an in-depth analysis of the 1985 Plaza Accord and the 1987 Louvre Accord, and "correcting" the long-held public perception of the success factors of these two agreements. Clarida stated that it is widely believed that the success of the 1985 Plaza Accord and the 1987 Louvre Accord was primarily due to the joint intervention of various countries in the foreign exchange market, which led to the depreciation of the excessively strong dollar at the time and reduced the massive trade deficit of the United States. However, he believes this is actually a "myth," or rather, a widely circulated misunderstanding. Clarida emphasized that the decisive factor was actually the adjustment of domestic monetary and fiscal policies in the United States at that time. Common Misunderstandings about the Plaza and Louvre Accords The article first briefly reviews the historical background during which the two agreements were reached. In the mid-1980s, the dollar exchange rate soared, and the U.S. trade deficit continued to grow, accounting for about 3% of GDP, while domestic protectionist sentiments became increasingly vocal. To address this issue, in September 1985, the five major industrial countries (G5) — the United States, Germany, Japan, the United Kingdom, and France — reached the "Plaza Accord" at the Plaza Hotel in New York, with the core goal of taking joint action to allow the dollar to depreciate in an orderly manner. Two years later, in February 1987, these countries signed the "Louvre Accord" in Paris. By this time, they felt that the dollar had depreciated enough and decided to stabilize the exchange rate together to prevent excessive market fluctuations. In hindsight, these two agreements did achieve their goals: by 1987, the dollar had indeed depreciated in an orderly manner; by 1989, the proportion of the U.S. trade deficit to GDP had also decreased by two-thirds. The article points out that it is precisely because of this outcome that many people, including some professionals, believe that it was the coordinated buying and selling of dollars by central banks that led to the dollar's depreciation and trade balance. Clarida bluntly pointed out that while this view is very appealing — after all, who wouldn't want to solve the trade deficit just by coordinating foreign exchange interventions? — it is actually incorrect. He emphasized that empirical evidence and academic research show that although coordinated intervention is symbolically important, it was not the main driving factor behind the dollar's depreciation from 1985 to 1987. The role of foreign exchange market intervention has been greatly overestimated, and it can even be said to be "a persistent myth." The Real Driving Factor of the Plaza Accord — U.S. Loose Monetary Policy So, if it wasn't foreign exchange intervention, what was the main cause of the dollar's depreciation? Clarida's answer is: the monetary policy of the United States itself He specifically mentioned then Federal Reserve Chairman Paul Volcker: "What really made the decisive difference was the significant easing of U.S. monetary policy under Volcker's leadership." The article states that when Volcker took office in 1979, he faced double-digit inflation, which he successfully brought down by the end of 1984, meaning the Federal Reserve had considerable room to cut interest rates. In fact, from October 1984 (11 months before the Plaza Accord) to December 1986 (2 months before the Louvre Accord), the Federal Reserve indeed slashed interest rates from a high of 12% down to 6%. Clarida observed that the weakening of the dollar occurred almost "in line with these rate cuts." The logic behind this is not hard to understand: as U.S. interest rates decline, the attractiveness of dollar-denominated assets to international investors diminishes, leading funds to flow into other currencies with higher interest rates, resulting in a depreciation of the dollar. Therefore, rather than saying that the "intervention" rhetoric of the Plaza Accord had an effect, it is more accurate to say that the Federal Reserve's concrete actions in cutting interest rates changed the market fundamentals. Fiscal Policy Plays a Key Role in Trade Balance In addition to monetary policy, U.S. fiscal consolidation also played a crucial role in reducing the trade deficit. Clarida pointed out that although the Reagan administration implemented tax cuts and increased defense spending in 1981, in the following years, the government and Congress cooperated to actually introduce several important fiscal tightening measures. These measures collectively reduced the U.S. budget deficit by nearly 40%. With the government spending less or increasing tax revenue, overall economic demand would cool down, including the demand for imported goods, which would also alleviate the demand for foreign capital, all of which helps improve the trade balance. Clarida emphasized that it is crucial that the initial Plaza Accord communiqué clearly stated that fiscal adjustments in the U.S., Japan, and Germany would be necessary to reduce global trade imbalances, and at least in the U.S., these adjustments were indeed implemented. Therefore, Clarida believes that policymakers must recognize that successful international coordination requires credible commitments at the monetary, fiscal, and geopolitical levels, rather than relying solely on foreign exchange intervention. The Concept of the "Mar-a-Lago Agreement" and Real-World Challenges Having clarified the history, Clarida then turned his attention to the present. Recently, with the election of Donald Trump as President of the United States, the so-called "Mar-a-Lago Agreement" has gradually attracted considerable attention, with the concept being proposed to draw on the experiences of the Plaza Accord to address current trade issues. The article also mentions that, in addition, economists such as Zoltan Pozsar and Stephen Miran, former chairman of the U.S. Council of Economic Advisers, have explored the possibility of coordinated intervention to lower the dollar exchange rate. There are even bolder ideas, such as swapping short-term U.S. Treasury bonds held by foreign central banks for long-term or even perpetual bonds, or linking monetary cooperation with security arrangements and tariff reductions, etc So, the question arises: Since Clarida believes that the success of the Plaza Accord mainly relied not on intervention, can the current "Mar-a-Lago Accord" intervention work? Clarida's answer is clearly negative. He believes that using the experiences of the Plaza Accord and the Louvre Accord to guide today must take into account the real challenges. First, the current monetary policy space may not be as large; for example, interest rates may already be very low, or inflationary pressures may prevent central banks from easily making significant rate cuts. Second, the prospects for fiscal consolidation are also unclear; governments may face enormous political resistance or heavy debt burdens. Finally, the geopolitical environment is much more complex than in the 1980s, and coordination among major powers is far more difficult than before