Column: Stirring Ingredients of the 1985 Dollar Cap Agreement: Mike Dolan

U.S. dollar banknotes are seen in front of a stock chart in this November 7, 2016 illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration/Files

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LONDON, May 11 (Reuters) – There’s a familiar air of 1985 about – and not just in Cold War politics or the gull-winged DeLoreans in ‘Back to the Future’.

With inflation rates as high as they were in the early 1980s, U.S. interest rates rising faster than those in other major economies, and the dollar exploding around the world, it’s no surprise to see investors refer to the “Plaza Accord” of 1985.

Named after the New York hotel where finance chiefs of the G5-era world powers agreed to weaken an overburdened dollar through market intervention, Plaza has become an iconic moment in the economic cooperation of the floating currency era after 1973.

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Supported by diverging monetary policies and Federal Reserve Chief Paul Volcker’s resolve to finally eradicate the double-digit inflation of the oil shocks of the 1970s, the ensuing extreme dollar strength destabilizing for US exporters and inflationary for US trading partners. The G5 resolved to correct the overshoot.

It was so successful in driving the dollar down against the German mark, Japanese yen, French franc and British pound that Western powers were forced to back down in Paris two years later and consolidate the note. green.

As the Fed tightens again post-pandemic, as long-dormant inflation rages at its highest level since 1982, the dollar index hit 20-year highs this month – gaining some 16% in one year and more than 30% over the past eight years.

There are good reasons to be concerned. The dollar is still so crucial to global financing, commodity prices and trade invoicing that extreme dollar strength tends to feed on itself – with a rising dollar exaggerating global financial stress and acting at both as a refuge and a protection against disturbances.

Additionally, the dollar is approaching what Cazenove Capital chief investment officer Caspar Rock calls “emotional levels” – although the resulting financial stress is probably not yet extreme enough for international action.

The euro/dollar is less than 5% of the parity observed 20 years ago. The pound is just 7% off pandemic lows against the dollar, below which 1985 levels are in sight. And the dollar/yen is above 130 for the first time in 20 years, although it’s still half the rate it was in the mid-1980s.

While the Fed may welcome a stronger dollar in its battle against inflation above 8%, European countries more dependent on energy imports and closer to Ukraine-related supply shocks can only see a stronger dollar exaggerate their cost-of-living squeeze. Japan will also balk at oil import bills.

If the currency markets are overshooting, as they so often do, could there be justification for an official jab at dollar strength? A Plaza-lite, perhaps?

G4 central bank rates and the dollar
G4 central bank rates in the 1980s


Hedge fund manager Stephen Jen at Eurizon SLJ thinks there’s good reason to look to the early 1980s for a “strong resemblance” to the current US economic policy mix – though he doubts we see a repetition of the excesses of this period.

For Jen, the combination of tight base money and loose government fiscal policy provided the perfect “mix” for currency appreciation both in the 1980s and still today.

Volcker’s anti-inflation push 40 years ago saw the Fed’s key rates hit 19% in 1981 and back into double digits in 1984 – as did then-President Ronald Reagan’s tax cuts. aimed to stimulate the economy and offset monetary pressure. .

What’s more, international monetary policies were polar opposites. As Fed rates soared in the first five years of the 1980s, Bank of Japan and Bundesbank policy rates nearly halved, from 9% to 5% and 9.5% to 5.5%.

The rise in the dollar has gone too far. The Fed’s broad trade-weighted dollar index more than doubled between 1980 and 1985, and the risk of financial instability around the world eventually led to Plaza.

There are many similarities to today – although the raw numbers pale in comparison.

The Fed’s broad dollar index has risen about 30% over the past eight years instead of doubling. US fiscal policy is loose, although it is tightening following the extremes of the pandemic. And the divergence in key rates is much more modest.

The Fed has started raising interest rates rapidly from zero, although futures markets are assuming they will hit just over 3% next year. The European Central Bank is expected to raise rates at a slower pace into just positive territory over the same horizon, but not in the opposite direction. The BOJ maintains its loose stance for now.

“We don’t think any major central bank is about to be able to repeat a ‘Volcker’, due to the very large balance sheets and associated distortions – including high leverage – that these monetary policies unconventional policies have conferred on the financial system,” Jen and her colleague Joana Freire wrote. “This, in turn, should mean dollar strength is likely to cap.”

Of course, the global economy and financial markets are very different beasts than they were 40 years ago. Currency positions are more blurred by quantitative easing and central bank balance sheet policies, direct intervention in foreign exchange markets may be less necessary or effective than anti-stress dollar swap lines established in the interim and larger trading blocks are perhaps less sensitive to currencies.

Clearly, China’s emergence as the world’s second largest economy means that the strength of the dollar against the yuan will also be a factor – and Beijing may have to be a party to any deal.

Yet a more polar world has reformed since the pandemic and Russia’s invasion of Ukraine this year. The G7 seems to have regained primacy as the West’s economic forum and the 1980s don’t seem such a distant memory all of a sudden.

Dollar on the month of March

The author is Finance and Markets Editor at Reuters News. All opinions expressed here are his own.

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by Mike Dolan, Twitter: @ReutersMikeD; Editing by Lisa Shumaker

Our standards: The Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias by principles of trust.

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