Is Plaza Accord 2.0 on the horizon?

As 2025 (and a new Trump administration) is approaching, many financial institutions have completed their scenario planning exercises to account for market risk, geopolitical risk, and more. Krishnan Ranganathan, Executive Director at Nomura, shares his personal take on the seemingly paradoxical policies promised during the campaign and draws upon historical data to support his predictions.

The IMF did not provide much guidance on the emergence of the floating regime in the 1970s. The task was left to more informal discussions between governments when the dollar appreciation hit US exports, encouraged imports and threatened a protectionist backlash in Congress. In Sep 1985, G-5 finance ministers and central bank governors secretly met at the Plaza Hotel in NY. For the Reagan administration, congressional protectionism threatened its agenda of deregulation and economic liberalisation; for the Japanese and Europeans it sabotaged their access to the US market.

The five governments published a joint statement emphasising the need for an “orderly appreciation of the non-dollar currencies” (a dry reference by politicians to dollar depreciation). They agreed to manage floating rates by adopting policies that would “resist protectionism, control inflation, liberalise financial markets, reduce taxation and cut public expenditure”. The Plaza Accord also made a commitment that exchange rates should “better reflect fundamental economic conditions” and would adjust external imbalances.

In reality, the Plaza agreement lacked credibility, for central bankers were wary of firm commitments and finance ministers were not keen to surrender control. Coordination was accepted in response to an immediate and serious threat; the moment the crisis passed, cooperation was dumped and national policies took precedence. This pattern repeated in the 1987 Louvre Accord. The discussion “took place over dinner, while all the participants were quite busy cutting their meat and sipping their wine. No effort was made to formalise the agreement and obtain firm commitments to the figures from the finance ministers… there were no ‘tangible, clear results’”.

Fast forward to recent times

Trump prefers most things strong— strong stock market, strong borders, strong China policy—but not a strong currency. Thanks to interest rates perched at their highest levels in 23 years, Trump’s calls for a weaker currency come as the dollar has risen by 15% against a basket of currencies since Biden took office in Jan 2021.

So is a Plaza Accord 2.0—surely now at the Trump International Hotel—on the cards?

Firstly, devaluation would contradict the longstanding G7 and G20 commitments to pursue exchange rate flexibility. In calling for devaluation, the US could be accused of triggering currency wars and indulging in exactly what it has long dissuaded others from doing.

Secondly, the US trading partners are far more varied, numerous and hostile than in the 1980s. Foreign governments manage their exchange rates less today than they did, capital flows are much larger, and China (not US allies) is the most important counterparty, making striking such a deal far trickier. China would be unwilling to allow a major yuan appreciation against the dollar, since that would hurt Chinese exports. Japan’s recent futile efforts to strengthen the yen show the perils of trying to distort market pricing. Of course, China’s recent economic woes make Plaza Accord 2.0 less outlandish as it still might be in its interest to join a coordinated global intervention to bring the dollar lower, since that would blunt protectionist pressures in the US, eventually benefiting Chinese exporters.

Thirdly, we have the paradox of Trump’s populist policies that would lead to a stronger dollar, not weaker:

• History is replete with examples of protectionists wreaking economic havoc. Trump wants to impose a 60% tariff on Chinese imports and 10% duties on those from the rest of the world. Tariffs could raise domestic costs, pushing inflation higher. Also, in line with his plan for mass deportations, Trump has promised to effectively close the southern border, again leading to wage inflation. Both outcomes will keep interest rates elevated. Perhaps he will try to coerce the Fed into action? If the Fed could be nudged into printing dollars or lowering rates, that would probably help bring down the dollar. Yet it is unlikely Powell could be bullied into doing this. Also, replacing him with a more pliable governor might not be legal.
• Trump would extend tax cuts expiring in 2025 and has planned further tax cuts that could add pressure to the yawning budget deficit and slow the pace of the Fed’s rate cutting cycle. A common thumb rule suggests that closing the current-account deficit by weakening the dollar would require roughly a 30% depreciation, which would boost inflation by 1-2%. That seems like a steep ask and a major financial stability risk even for an ambitious new government.
• The US, for all its problems, is perceived as a safe haven. The dollar makes up 59% of the world’s central-bank reserves and is used to pay for half of its goods trade. The global appetite for Treasuries reduces the interest bill associated with the US’s vast public debt. The depth of US capital markets, its commitment to the rule of law and the low risk of a default make it a magnet for savings. Calling for devaluation could question those very properties as being inconsistent with the Republican party pledge to “keep the US dollar as the world’s reserve currency”.
• This leaves us only with one option. Capital controls used to be common, even in developed nations, but came down after 1980, as economists preached that the free flow of money across borders would enhance global productivity by getting resources to their best use. It is improbable that US would implement the kind of restrictions that China has in place, but it could make flows of capital a little less free, e.g. by imposing a tax on foreign purchases of US financial assets. This idea has been floated by Lighthizer as a tool to bring down the trade deficit. It could raise government-bond yields or reduce stock prices. Given that Trump takes pride in a strong stock market, this could be a non-starter. The Treasury could sell dollars to buy foreign currency. Between 2014 and 2017 China spent 3% of GDP p.a. trying to support the value of its currency. With the US running a large budget deficit, borrowing huge sums just to buy up foreign currency might not appeal, especially if funds are limited by the debt ceiling and could finance tax cuts.

The jury is still out on whether it really was the Plaza Accord that drove down the dollar in the 1980s. The dollar fell by 4% against the yen and the deutsche mark the day the Plaza communiqué was released, and it continued to fall subsequently. However, no change in monetary and fiscal policies had been undertaken (or even discussed) at the Plaza. This, coupled with the fact that the dollar had already begun to decline six months earlier, led some to conclude that the deal was inconsequential—the dollar’s fall was just the unwinding of an unsustainable appreciation. The governments of George Bush and Bill Clinton showed little interest to adjust policies to stop the currency's fall. A typical Bush reaction to a falling dollar was, “Once in a while, I think about those things, but not much.” Bush was simply swimming with the (political) tide.

A similar story is at play now. After two years of tight monetary policy, inflation seems to be falling. Though second-guessing exchange rates is a fool’s errand, the anticipated rate path may limit dollar demand, bringing it down from its highs. Hence, in the light of expected Fed cuts, dollar depreciation may well be on its way.

According to Tetlock, someone who knows the difference between a 45/55 bet and a 55/45 bet is a better decision-maker than someone who thinks in binary terms. As The Economist noted, winning in Trump’s kakistocratic world will require taking a lot of 55/45 bets.

Krishnan Ranganathan is an Executive Director with Nomura and is the India Co-Head of International Change, responsible for the execution of global regulatory and transformation projects. He is an alumnus of Harvard Business School and is a member of the Young Scholars Initiative at the Institute for New Economic Thinking. Views are personal.