In retrospect, it may have seemed like a sound decision at the time. Government policymakers often believe they can enhance the natural order, disregarding the unforeseen repercussions of their interventions, convinced they can simply resolve issues with another policy adjustment later.
During a meeting at New York’s Plaza Hotel on September 22, 1985, officials from West Germany, France, the United States, Japan, and the United Kingdom unwittingly unleashed forces that would prove nearly impossible to control.
By 1985, fourteen years after President Nixon abandoned the gold standard, floating currencies had led to severe imbalances in the global economy. The U.S. dollar had surged by 50 percent against the Japanese yen, West German Deutsche Mark, and British pound—currencies from the three largest economies at the time. This dramatic appreciation rendered American manufacturers less competitive as foreign imports became significantly cheaper for U.S. consumers, contributing to a staggering trade deficit of 3.5 percent of GDP.
The Plaza Accord aimed to devalue the dollar and restore equilibrium to global trade. This marked a pivotal moment in which central bankers coordinated their interventions in currency markets, prioritizing the global economy over national interests. While the Accord achieved its goal—with the dollar depreciating by 51 percent against the yen between 1985 and 1987—the unintended consequences soon surfaced in Japan.
To counteract the recessionary pressures linked to the rising yen, the Bank of Japan responded by lowering interest rates, initiating a series of expansive monetary policies that ultimately birthed a massive asset bubble in Japan by the late 1980s. By 1989, real estate in Tokyo’s Ginza district was trading at a staggering $20,000 per square foot. However, by 2004, these prices had plummeted by over 90 percent. The stock market experienced a similar, albeit dramatic, rise and fall…
A Grim Forewarning of Future Challenges
In September 1985, at the Plaza Accord’s inception, the Nikkei 225 index stood at approximately 12,667. Fast forward to December 29, 1989, and that figure had soared to 38,916—an increase exceeding 207 percent. Yet, as of yesterday, it closed at 10,824, reflecting a decline of over 72 percent—even more than 23 years later. Investors who purchased stocks in December 1989 and held onto them may experience decades of waiting before seeing any return on their investments, if they ever do.
Following the burst of Japan’s asset bubble, the country’s economy entered a prolonged downturn. Despite extensive government stimulus and deficit spending, Japan’s economic growth remained stagnant. Initially, the severity of the situation was not apparent, but ominous signs became increasingly detectable for those paying attention.
For instance, on January 8, 1992, after the collapse of Japan’s prolonged credit-fueled asset bubble, President George H.W. Bush, during a visit to Japan, leaned in to whisper to Prime Minister Kiichi Miyazawa, possibly to share strategies for a financial rescue. In a darker twist of fate, he vomited on his lap.
Japan’s economy has yet to recover from those events, essentially “throwing up” on itself repeatedly. As of now, Japan’s government debt stands at a staggering 230 percent of GDP, the highest among any industrialized nation. Comparatively, the United States holds a debt-to-GDP ratio of 103 percent, but Japan has managed to finance its debt primarily through domestic means.
Japan has historically managed to avoid international borrowing due to its favorable trade balance. By exporting more than it imports, Japan’s population could use that revenue to help bridge governmental funding gaps. However, this situation may be changing.
The Onset of Currency Wars and Economic Desperation
In 2011, Japan experienced its first trade deficit since 1980. This deficit expanded further in 2012, totaling $78 billion. If this trend continues, Japan may be forced to seek foreign investors to support its government debt, leading to higher demands for returns on the currently low yields—around 0.75 percent on 10-Year Japanese bonds.
Consequently, Japan’s path forward will require reversing the strategies of the Plaza Accord. To regain competitiveness, the country must devalue its currency to enhance export capacity. However, other nations are likely to respond with caution, given the sensitivity of global trade dynamics.
Recently elected Prime Minister Shinzo Abe has taken on the daunting task of leading an economy that faces dire challenges. He has no choice but to pursue inflationary measures. In response to mounting pressure, the Bank of Japan declared its intention to implement an open-ended asset purchase plan and set a 2 percent inflation target. Additionally, the yen has depreciated by 15 percent against the dollar in the past two months.
By the end of last week, finance ministers from Germany, China, the United Kingdom, Russia, and Thailand expressed concerns that Japan’s currency devaluation could spark a currency war, as nations vie to devalue their own currencies for competitive advantage.
As economic struggles linger, governments and central banks will continue to seek prosperity through currency manipulation. In this new era of desperation, a race to the bottom may be unfolding.
Sincerely,
MN Gordon
for Economic Prism
Return from Currency Wars and the New Age of Desperation to Economic Prism
