International Monetary Cooperation: Lessons from the Plaza Accord after Thirty Years

I

OFFICIAL RECOLLECTIONS

1

The Architect

JAMES A. BAKER, III

James A. Baker, III, was the 61st US Secretary of State from January 1989 through August 1992 under President George H. W. Bush. He was the 67th Secretary of the Treasury from 1985 to 1988 under President Ronald Reagan. As Treasury secretary, he was also chairman of the President’s Economic Policy Council.

Remarks as prepared for delivery.

First and foremost, I want to recognize a very special person who played a critical role in the Plaza Accord: Paul Volcker. None of what we accomplished at the Plaza Hotel 30 years ago would have happened without the support of a man whom history has shown was a great chairman of the Federal Reserve. His skillful reduction of inflation in the early 1980s—combined with President Ronald Reagan’s fiscal policies—helped lead to the fantastic domestic economic growth that followed.

Paul could not be here today, but he will be speaking to us at lunch via a taped interview. It’s an honor to have him here in this way, because we all owe him a debt of gratitude for his magnificent service to our nation.

Now before I begin, I want to brag a little bit about the Baker Institute and its founding director, Ambassador Edward P. Djerejian. Ed has led the Institute since it opened in 1993, helping it become the 18th best think tank in the United States and the 9th best university-affiliated think tank in the world, according to a University of Pennsylvania ranking last year. Before then, he was the US ambassador to Syria and then Israel—the only person to hold both positions. I suspect if you press him, Ed will confess that the demand for adroit diplomacy is much greater on college campuses than it is in the Middle East. Fortunately, he’s been successful in both arenas.

I would also like to recognize several people here today with whom I worked 30 years ago on the Plaza Accord when I was secretary of the Treasury. They include:

■ David Mulford, who was then assistant Treasury secretary for international affairs and is now vice chairman international of Credit Suisse;

■ Edwin Truman, who was then director of the international finance division of the Federal Reserve Board of Governors and is now a senior fellow at the Peterson Institute for International Economics;

■ Charles Dallara, who was then the United States’ executive director of the International Monetary Fund and is now the executive vice chairman of Partners Group Holding; and

■ Makoto Utsumi, who was then head of the economic section of the Japanese Embassy in Washington and is now the chairman of the global advisory board of Tokai Tokyo Financial Holdings.

I want to talk to you today about the lead-up to the Plaza Accord; what happened when we successfully coordinated macroeconomic policy among the world’s principal economies in the 1980s; and finally, the need for greater coordination in today’s complex world.

What happened 30 years ago at the Plaza Hotel in New York City was, in many ways, a continuation of the type of international cooperation that had characterized global economics since the end of World War II. During the aftermath of World War I, US policymakers had pulled up the drawbridges and tried to insulate our country from economic problems elsewhere in the world. Essentially, they wanted to keep whatever growth they could generate to themselves.

Those policies did exactly the opposite of what they had hoped. International trade and capital flows dried up, and with them, economic growth. The isolationism and protectionism of that era in part helped cause the Great Depression and arguably set the stage for World War II.

America’s decision to stress economic cooperation 70 years ago was also part of our broader strategy to rebuild post–World War II economies and, by so doing, foster stability. Under our leadership, 44 nations signed the Bretton Woods agreement in 1944, setting up the International Monetary Fund and the World Bank. The dollar was pegged to gold, and other world currencies were pegged to the dollar. Soon thereafter, the General Agreement on Tariffs and Trade was put in place to promote free trade. These agreements provided a foundation for postwar global prosperity.

By the time I became secretary of the Treasury, in 1985, we weren’t worried about another Great Depression, even though we had gone through a terrible economic downtown only a few years earlier. The Reagan tax cuts and the Fed’s successful war on inflation had set the American economy afire. As the US economy grew, so did the global economy.

What concerned us was how to maintain this prosperity in the face of unsustainable, and growing, global economic imbalances. We were confronted with an overvalued dollar (when measured against other currencies) and a trade imbalance that favored the Japanese, the Germans, and other trading partners at the expense of US manufacturers and exporters.

Once again, a protectionist fever was burning in Congress. It was difficult for our Republican administration to beat it back, especially since the House of Representatives was controlled by Democrats. And it grew hotter each time Honda or Mercedes won another customer from the Big Three.

Would we return to the failed go-it-alone policies of the Great Depression? We were determined that this would not happen. We at Treasury concluded that the best—and perhaps the only—way to solve these problems was to work more closely with the finance ministers and central bankers of other major economies.

Item one on our agenda was the dollar. For some years, relative world currency values had been set by the market. Sometimes they fluctuated wildly on foreign exchanges. This made it difficult for governments, companies, and investors to make long-range plans. A business could do everything right, then be ruined by a sudden overnight move in exchange rates. And the disparity between the strong dollar and weak foreign currencies gave foreign competitors a big advantage over companies in the United States. This contributed to our growing trade deficit and sparked demands for high tariffs, import quotas, and other protectionist measures.

Of course, there is no practical way to establish what may be the most effective solution: a global currency. A single global currency would make it easy to buy, sell, and invest in markets from China to Brazil with perfect confidence in the medium of exchange and with no currency risk. But that, of course, couldn’t happen. So we decided to try to coordinate the underlying economic fundamentals of the major currency countries. To be effective, we would have to do so with regularity. That process was begun with the Plaza Accord in 1985.

My first stop in this effort at international economic policy coordination was the White House, the home of the only decision maker in the executive branch of the US government. President Reagan liked the idea, and with his approval, we were in a position to go forward without telling anyone else. A leak could have destroyed the effectiveness of what we were planning.

We also needed the support of the Federal Reserve and Chairman Volcker, who had been on record since early 1985 in favor of correcting the problem of the overvalued dollar. He, too, liked the idea.

We then made secret contacts with the finance ministries of the four other major currency countries: Germany, Japan, the United Kingdom, and France. There was predictable skepticism, but as the summer of 1985 wore on, they began to realize that we were indeed serious.

Our leverage with them was that if we didn’t act first, the protectionists in Congress would throw up trade barriers. Automakers and other industries were pounding the desks at the White House, Treasury, and Congress, demanding that something be done to save them from foreign competition. And Congress was listening. By late summer, top foreign economic officials had begun to see that we were serious.

Finally, we all met on Sunday September 22, 1985, in the Gold Room of New York’s lovely old Plaza Hotel. All participants had managed to arrive secretly for that Sunday afternoon meeting. We picked that day because financial markets would be closed.

We didn’t tell the press until the meeting was under way. Once alerted, of course, they showed up in droves. The room was packed.

By the end of the day, we had announced what came to be known as the Plaza Accord.

The results were spectacular. Despite strong resistance from traders, the dollar dropped against other currencies, quickly and substantially, but in an orderly way.

But the Plaza was about more than just currency adjustments. It also established the practice (for a while, at least) of multilateral economic policy coordination. Among other things, the United States undertook to control its fiscal deficit with the Gramm-Rudman-Hollings Act, which slowed the rate of growth of federal spending (although, frankly, it didn’t go far enough). Japan agreed to stimulate domestic demand and open its borders to more imports, and Germany said it would reduce the size of its public sector and remove excessive regulations that inhibited labor and capital markets. Importantly, all signatories promised to fight protectionism.

In time concerns grew that the dollar might have fallen too far. This led to the Louvre Accord of February 22, 1987. While the Plaza was a one-time agreement to deal with a specific set of circumstances, the Louvre was more ambitious. It aimed to institutionalize the process of coordination of economic policies to stabilize world currencies within an agreed, but unpublished, set of ranges. Like the Plaza, it also worked for a while.

By 1987 the US current account deficit—which the Plaza communiqué had cited as evidence of trouble in the global economic system—had begun to fall. In 1991 it reached zero. Talk in Congress about erecting trade barriers never completely died away, but it subsided. The Reagan economic boom continued, and the world’s economy grew with it.

Of course, multilateral coordination of economic policy is very difficult politically for all countries involved. After I left Treasury, in 1988, the process continued for a short time, then fell dormant. In President Clinton’s second term, Robert Rubin briefly revived it to successfully deal with the East Asian economic crises. Otherwise, and sadly, the process largely ended with the Reagan administration.

Admittedly, the circumstances today would make it harder to achieve this goal than it was 30 years ago. When we reached the Plaza Accord, we were dealing with the countries of the G-5: France, Germany, Japan, the United Kingdom, and the United States. Today that group has grown to become the G-20, and China has emerged as a global economic powerhouse.

Still, there are similarities between then and now. The US current account balance today is about 2.7 percent of GNP, a big drop from where we stood in 2005, when it was 6.5 percent. Nevertheless, it is at about the same level as it was in 1985, when we were so worried.

Furthermore, the global economy has not fully recovered from the crash of 2008—much as it had not fully rebounded in 1985. Our growth today is steady but unspectacular. Europe, as a whole, is growing very slowly. And the recent problems with China’s stock market—and that government’s failed efforts to correct them—foreshadow possible future economic distress.

And so, ladies and gentlemen, I submit that we definitely should embark once again upon a sustained, regular, and comprehensive effort to coordinate international economic policy. Yes, we are living in a new economic world, with more players, more complex markets, and gigantic capital flows. But that is no reason not to make the effort. If we want to maximize long-term growth, minimize the risk of protectionism, and create greater stability in foreign exchange rates, we should learn from our experience with the Plaza Accord and work consistently, vigorously, and in a regularly sustained way to coordinate our macroeconomic policies.

Obviously, that will require leadership from many countries—but most of all from the United States, the world’s largest economy and the continuing home of the de facto reserve currency of the world.

2

An Interview with Paul A. Volcker

RUSSELL A. GREEN

Russell A. Green is the Will Clayton Fellow in International Economics at Rice University’s Baker Institute and an adjunct assistant professor in the economics department there.

Paul Volcker acted as chairman of the Federal Reserve from 1979 to 1987, and in that role participated in the Plaza Hotel meeting and press conference announcing the Accord. The previous chapter by Secretary Baker mentions how essential it was to obtain Volcker’s assent to pursuing the Accord. Indeed, a picture from the press conference shows Baker grabbing Volcker to put him in front of the line-up of finance ministers, a light-hearted visual metaphor for how the Federal Reserve’s cooperation would be crucial to the aims of the Accord (see photo on the next page).

In the interview, Volcker lays out his support for greater international economic coordination, both three decades ago and today. He explains, however, the concerns central bankers have with exchange rate intervention and coordinated economic policies. He emphasizes that the natural primacy policymakers place on domestic objectives—not just at central banks—disrupts most efforts at coordination. He feels we are likely left with our dollar-centric messy system for now.

This interview was conducted on September 28, 2015, shortly after the 30th anniversary of the Plaza Accord and three days before the Baker Institute conference, via teleconference between Houston and New York.

Russell Green: First, Mr. Volcker, let me thank you for talking to me today. It’s quite an honor for me to ask some questions about the exchange rate.

Paul Volcker: I regret we have to do this at a distance, but here we are.

The finance ministers who signed the Plaza Accord: from left, Gerhard Stoltenberg of West Germany, Pierre Bérégovoy of France, James A. Baker, III of the United States, Nigel Lawson of the United Kingdom, and Noboru Takeshita of Japan.

© Bettmann/Corbis. Photographer: Harbus; Rich

Green: Let me ask you first sort of an open-ended question: What do you think made the policy coordination efforts in the 1980s possible, and what made them successful or fall short of their potential?

Volcker: I didn’t think of the efforts in the 1980s as being marked by a lot of coordination. There was no coordination in the early part of the 80s, so far as I remember, but you had change in personnel in the US Treasury Department, and the new secretary of the Treasury and his associates were much more activist in achieving coordination with some other countries. So there was a change during that period and it was all kind of symbolized by the so-called Plaza Accord.

Green: After the Plaza Accord got going, would you say that there were factors that made that effort of coordination more successful or factors that made it fall short of its potential?

Volcker: I was not an enthusiastic proponent of the Plaza Accord. I was not against it, but I was a little fearful. I thought the dollar was going to decline, and it was declining on its own. From the central bank standpoint, you’re never happy about pushing your own currency down, you think it might get a little out of hand. So we had a lot of discussion as to how we were going to maintain or at least avoid a free fall. In fact, when the program was announced, you had a decline in the dollar, and there was some intervention. But there wasn’t much intervention afterward, because the dollar did fall on its own, but against the background, obviously, of intent. So the Plaza Accord certainly contributed toward sizable realignment of currency value, which I do think was necessary.

Green: You mentioned the fear that the dollar might fall in an uncontrolled manner. It seems like central banks in the 1980s were more willing to include exchange rate objectives in their monetary policy decision making than they were in subsequent decades.

Volcker: I’m not sure I agree with that observation. It was a long time ago, but we had a particular problem in the United States. The priority was to deal with inflation. We conducted a restrictive policy, and it resulted, among many other things, in high interest rates and a big appreciation of the dollar. During that period, frankly, the US Treasury was not interested in doing anything to modify that, from the standpoint of intervention or otherwise, which from my standpoint was not very useful or constructive, but nonetheless that was the policy at the time. Then later, beginning in 1985, I guess, conditions changed, the Treasury attitude clearly changed, and it was much more interested in achieving some coordination internationally.

Green: So from the Federal Reserve standpoint, the exchange rate was certainly not the primary objective. Do you think it was the same for your counterparts at, say, the Bundesbank or the Bank of Japan?

Volcker: This was a long time ago, but my memory is that the Bundesbank—which ordinarily was not very pro-intervention during that period—finally in 1984, I suppose, was worried about the relative decline in the mark. They unusually wanted to intervene, and we refused to intervene at the same time to support what they were doing. Now that was an incident that didn’t last very long, but it was an example of lack of cooperation internationally.

Green: Once the Plaza Accord took place, and the intervention at least superficially appeared to have been effective, there seemed to be much greater enthusiasm among finance ministries for coordination, at least in the set of meetings that led up to the Louvre Accord.

Volcker: That’s true. Of course, Secretary Baker was a leader in that effort.

Green: Did that create complications for domestic monetary policy?

Volcker: I don’t recall that creating particular problems in domestic monetary policy at the time the Louvre was put in place. The strictures of the Louvre Accord were violated in a few months. And I can remember from my viewpoint, you might have argued—I don’t remember when it was, April or May of 1987—that the Federal Reserve could have tightened more to help maintain the stability of the dollar. We weren’t as vigorous as we might have been. But it was a limited area of change or controversy at that point. You didn’t get the big change until later in