U.S. President Donald Trump likes to model himself, whenever it's convenient, on another Republican president – the revered Ronald Reagan. Both are/were screen stars turned politicians. Both have/had a popularity with the masses that the intellectual class find/found hard to fathom. And both have/had big problems with the undervalued currencies of their foreign competitors that, they argued, were unfairly harming U.S. exporters.
So you have to wonder whether the new President is already thinking about pursuing Mr. Reagan's solution to the problem. Could we be on the road to a Plaza Accord II?
The notion has been a hot topic of debate in economics and financial-market circles in recent weeks, as the new President has cranked up the rhetoric about U.S. trade imbalances and what he's prepared to do about them. Mr. Trump may not be the most detailed of history buffs, but he and his Republican advisers are well aware that Mr. Reagan was able to rebalance the global currency playing field, winning landmark concessions from his country's biggest international competitors by wielding one of Mr. Trump's favourite weapons: The threat of U.S. protectionist actions.
Under the Plaza Accord of 1985, the central banks of the world's five most powerful free-market economies of the time – the United States, Japan, West Germany, Britain and France – agreed to intervene in currency markets in a co-ordinated program to drive down the U.S. dollar. And it worked: In less than two years, the U.S. dollar lost roughly half its value against the other four currencies, and the countries signed a new agreement (the Louvre Accord) to work together to halt the greenback's decline. By 1991, the U.S. trade deficit had been cut in half.
Today, Mr. Trump's administration has taken shots at China, Germany and Japan over what he has labelled as, essentially, intentional competitive devaluations of their currencies. The threats of protectionist retaliation, veiled and not so veiled, are out there.
Does Mr. Trump have a case? Well, to some degree, yes.
The U.S. dollar has surged 27 per cent against a trade-weighted basket of major foreign currencies since mid-2014. And there's little doubt that many central banks have seen low-interest-rate policies as a means to improve their economies' export competitiveness by weakening their currencies. (Most central banks, including Canada's, wouldn't put it quite so bluntly. But in the post-financial-crisis era, where domestic demand in many countries has struggled, reviving exports has been seen as a salve for many economies. And central banks, dedicated to growth-promoting monetary policy, fully understand that weak currencies grease the export wheels.)
Recent analysis from the European Central Bank itself suggests that, at its current value, the euro (which Germany uses) has a competitive trade advantage of about 13 per cent over the U.S. dollar – certainly an indication that the euro is undervalued relative to its U.S. counterpart. Meanwhile, respected global finance and banking research firm BCA Research estimated this week that the Japanese yen has been trading in the ballpark of 15 per cent below its fair value – about as undervalued as it was during the Plaza Accord era. In both cases, aggressive monetary easing by the European and Japanese central banks has played a major role in keeping down the relative values of the currencies.
But BCA argued in a recent report that there isn't the same impetus for a Plaza-style accord today as there was in 1985. It said the U.S. dollar "had entered a full-fledged bubble" in 1985 – it had been on a seven-year bull run that had raised its value by more than 50 per cent, and was continuing to climb even though U.S. interest rates were declining relative to its major counterparts. The current rally in the U.S. dollar has been much shorter-lived and, when it began in mid-2014, the currency "was highly undervalued."
What's more, the current rally in the U.S. dollar has come at a time when the U.S. central bank, the Federal Reserve, has been raising interest rates and is expected to raise them further this year, reflecting a relatively strong U.S. economy. That's ample justification for the currency to be rising.
Meanwhile, China – traditionally the biggest target of the U.S.'s currency ire – can make a pretty strong case that its currency isn't undervalued. No less authority than the International Monetary Fund has said so for the past year and a half. The yuan has held up better than most currencies against the U.S. dollar's rise; China's central bank has actually been intervening to prop up its currency, rather than devalue it.
These distinctions probably wouldn't matter much to Mr. Trump, who hasn't shown a tendency to get too bogged down in the facts when formulating economic and foreign policy. But they are probably meaningful enough that a Plaza-style devaluation pact will be a very hard sell indeed with the U.S.'s key trading partners. No matter how much protectionist sabre-rattling is behind it.