30 years on, parallels with Plaza but currency universe very different

30 years on, parallels with Plaza but currency universe very different

LONDON Imagine a communique drafted by the world’s top economic powers today on the health and direction of the global economy and finance.

Few would be surprised by the following lines:

“The current sustained expansion is occurring within a framework of declining inflation … Inflation rates … show no signs of reviving … There has been a significant fall in interest rates in recent years…”

And while it would be dynamite in the foreign exchange markets, this line would also not look out of place in 2015:

“Some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. (Ministers and governors) stand ready to cooperate more closely to encourage this when to do so would be helpful.”

These lines come not from the statement issued last weekend by the Group of 20 leading economies meeting in Turkey but from one of the most famous inter-governmental economic communiques ever, signed 30 years ago this month and remembered with awe in financial markets as the “Plaza Accord”.

The parallels are clear — now, as in 1985, the dollar’s strong rise has been a key factor driving global economic growth, financial flows and policy. But it is much harder today, in an infinitely more inter-connected and complex financial and economic landscape for policymakers to guide exchange rates.

On September 22, 1985, at the Plaza Hotel in New York, the Group of Five leading industrialised powers – the United States, Japan, West Germany, Britain and France – agreed to act to reverse the destabilising surge in the dollar, which had gained more than 50 percent in value over the previous seven years.

The combined force of the G5 was so successful that less than two years later, with the dollar down some 40 percent, they, together with Canada, had to reconvene in Paris to forge what became known as the “Louvre Accord”.

Contrast those two landmark accords with the G20 communique issued in the Turkish capital Ankara last weekend in which they repeated their mantra of promoting more flexible exchange rates and warning against competitive devaluations.

Achieving consensus among 20 diverse countries, which include “emerging” economies such as China, Turkey and Brazil, is clearly far more difficult than it was three decades ago for the much more close-knit G5 club of advanced economies.

VOLATILITY

And the global economy, central banking and financial markets are unrecognisable today from 1985. What was measured in billions is now measured in trillions, minutes are nanoseconds and economic liberalism is now blanket orthodoxy.

Nick Parsons, global co-head of FX strategy at national Australia Bank in London, remembers Plaza well. He recalls his first ever FX trade as an investment manager in late 1984 was to sell dollars at 248 yen, only to see the exchange rate move 13 yen the other way to 261.

He was called to explain his view and whether he still believed it. He did, and the position was closed out at 160 yen in 1986, in large part thanks to Plaza.

Such extreme currency misalignments aren’t visible today, so the starting point is very different.

“But what we have got is a greater inter-connectedness of different asset classes, such that currency movements reverberate through other assets in a way they didn’t previously,” Parsons said.

“The potential for knock-on volatility in other asset classes is immense,” he said.

With central banks having slammed global interest rates to their lowest in history following the 2007-09 crisis, the exchange rate is one of the few levers policymakers have left to boost the competitiveness of exports and ultimately growth.

This race to the bottom is what then Brazilian finance minister Guido Mantega five years ago termed as global “currency wars”.

Plaza and Louvre stood out in a period of break-neck globalisation and market liberalisation, even though there followed several instances where global central banks intervened together in the world’s foreign exchange markets.

The U.S. Federal Reserve, the Bank of Japan and European central banks regularly intervened together in 1994-95 to support the dollar, while the Fed, BOJ and newly-created European Central Bank came together in 2000 to prop up the fledgling euro.

Since becoming a free-floating currency in the early 1970s the dollar has gone through two major rallies, both lasting seven years. It rose more than 50 percent in the period 1978-1985, and around 35 percent in the years 1995-2002.

If history is a guide, the greenback’s current trend – up about 20 percent in the four years to August 2015 – has three more years to run and plenty of upside potential too.

MORE COOPERATION?

But there have been flashes of volatility recently which have unnerved investors and policymakers alike. One was Monday August 24, when the dollar tumbled against the yen by as much as four big figures in a matter of minutes before snapping back.

This came at the end of a month that saw these global currency wars ratchet up to another level – several emerging market currencies sank to historic lows against the buoyant dollar – after China entered the fray and devalued the yuan.

Hans Redeker, global head of currency strategy at Morgan Stanley in London, agrees that “the conditions aren’t in place” for another Plaza or any level of direct, coordinated intervention in the market right now.

For a start, “someone would have to give in,” he said. To tackle exchange rate volatility, policymakers must address its root cause – the divergence in expectations for relative investment returns.

“I think people want to remain flexible on FX, but what you could have is more cooperation between policymakers in stabilization mechanisms,” Redeker said.

These “mechanisms” are fiscal policy, monetary policy and structural reforms, according to Redeker, the effects of which will all take years to be felt.

(Reporting by Jamie McGeever; Editing by Gareth Jones)

30 years on, parallels with Plaza but currency universe very different