The Plaza Accord Sequel

Yasuhiro Nakasone, Prime Minister of Japan from 1982 to 1987, enjoyed the ‘Ron-Yasu’ friendship with Ronald Reagan.? Nakasone sought a collaborative relationship saying, “President Reagan is the pitcher and I’m the catcher.? When the pitcher gives the signs, I’ll cooperate unsparingly, but if he doesn’t sometimes follow the catcher’s signs, the game can’t be won.”?

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This pitcher-catcher collaboration was on full display with the signing of the Plaza Accords in 1985 between France, West Germany, Japan, the UK, and the U.S. to depreciate the dollar in relation to the franc, mark, yen and sterling by intervening in currency markets.? Paul Volcker’s tight monetary policy and Reagan’s expansionary fiscal policy pushed up interest rates that attracted capital inflows.? As the dollar kept appreciating, the trade deficit grew to an unprecedented $145 billion at the time or 3% of GDP.? Today this figure seems quite benign as the deficit expanded to 4% to 6% of GDP throughout much of 2000-2015.? More recently America First has edged this down to about 2.8% of GDP down from 3.7% in 2022.?

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But the dollar continues to strengthen and with a growing likelihood of a presidential change in November, the odds of a Plaza Accord sequel are growing.?

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The Potential for A Radical Treasury Secretary?

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Robert Lighthizer served as U.S. Trade Representative under Donald Trump.? Lighthizer encouraged Trump to slap tariffs of 25% on steel and aluminium, impose tariffs on 75% of Chinese exports to the U.S., and renegotiated NAFTA.? Despite some initial opposition from Janet Yellen, Joe Biden kept these initiatives in place.? Lighthizer was one of the few that stuck around for Trump’s entire four years and he continues to enjoy high standing with the former president, and is on the short list for Treasury Secretary.?

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Lighthizer’s 2023 book No Trade is Free is an indictment on trade liberalization.? Franklin Roosevelt to Barack Obama believed that negotiated reductions of global trade barriers would make the U.S. richer and safer.? Lighthizer disagrees.? He warned against admitting China into the World Trade Organization.? He writes that reducing tariffs and binding Washington’s hands with global trade rules was “a starker, more indisputable failure than even I could have predicted” leading to the loss of U.S. manufacturing, the stagnation of American wages and a deteriorated strategic position versus China.? “Political establishments of both the Republican and Democratic parties, under the influence of multinational corporations and importers, were unwilling or unable to recognize their mistakes.”

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Most economists believe the trade deficit is a result of the negative national savings rate, where the U.S. consumes and there is low private and public savings.? In other words, Americans like shopping more than other countries.? The Mercatus Center says the best way to reduce the trade deficit is to increase the savings rate by cutting the federal budget deficit.? However, austerity is a tough concept to sell to the electorate these days.?

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Lighthizer sees the deficit as a direct transfer of U.S. wealth to competitors that can be corrected through government action.? He has been counselling Trump to devalue the dollar to boost U.S. exports.? He wants to rebalance the trade deficit with the rest of the world, not just China.? Tariffs would be imposed on trading partners unless they agree to take steps to revalue their currencies.

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There are several methods that could be used to lower the value of the dollar.? One could be having the central bank lower interest rates.? This policy would be highly inflationary when people are still complaining about egg prices and inflation jokes are prevalent (my favourite: “gas prices are so high that even the coronavirus stopped travelling”).? This also wouldn’t change the primary driver of the trade deficit, China, which pegs its currency to the dollar.? A theoretically promising tool is a sterilized intervention, where the Fed would sell U.S. Treasuries and then buy Chinese bonds.? This would offset what China does to maintain its peg where they accumulate dollar reserves and buy U.S. assets.? However, this is complex and would involve changing the Fed’s mandate.? While intellectually elegant, it’s probably unfeasible.?

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The most likely scenario is like the Plaza Accord where the U.S. would sit in a room with other nations, and pressure other countries to sell bonds and appreciate their currencies.? However, the trade partner that needs to do this the most is China, and they will probably not agree.? So, the only way to address the issue are higher and higher tariffs on Chinese goods. ?Lighthizer would keep raising tariffs 10% per annum until a trade balance is achieved.? He would get rid of the minimum exemption on duties that has allowed China’s Shein to take 30% of the U.S. fast fashion market.?

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Lighthizer is also part of a Trump-affiliated group which published the book “An America First Approach to US National Security.”? The book argues for decoupling from China and making Chinese Communist Party policies irrelevant to American life. ?The book also calls for preserving Taiwan’s security and urges allies to contribute more to the strategic burden.

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This has a few implications for markets if Trump wins and Lighthizer appointed: potential appreciation of the yen and European currencies; more tariffs and the potential for higher inflation; and a potentially negative market dynamic for China which is trying to push export led growth.?