Plaza, or Louvre?

The 1985 Plaza accord sought to drive the dollar down; the 1987 Louvre sought to keep the dollar from falling further. There is growing talk of a new Plaza in the US -- though not in the circles that count. Either a new Plaza or a new Louvre imply multilateral economic coordination, something this Administration does not like.

It would not take much to get the dollar to fall -- foreign (Asian) central banks would just have to stop propping it up. The coordination in a new Plaza would come in two ways: less central bank intervention implies less cheap financing and a sharp rise in US interest rates unless the US takes offsetting steps, like a serious plan to reduce its fiscal deficit; a shrinking US trade deficit also implies the US won’t be supporting global demand, so others will need to pick up the slack.

To be honest, I think their might well need to be a third, more controversial, type of coordination as well. Without continued central bank financing during the adjustment process, the US could be forced to adjust too quickly. There might be need to reach agreement on which central banks will bear the burden of propping the dollar up during its orderly fall -- though it is a bit hard to talk of sharing the burden of supporting a falling dollar when the dollar is currently being supported so strongly that it has not moved at at all against some key currencies! Right now there is a surplus of central bank support for the dollar in parts of Asia, not a deficit ...

Still, it is important to remember that the US will not be able to go from $400-500 billion in central bank financing a year to a more normal number of $100 billion over night. The US needs to go on a diet, but putting the US on a starvation diet would not be good for the US, or the world.

All talk of coordination is a bit theoretical when the Bush Administration has no interest in coordination, and its main policy initiative -- partial social security privatization -- implies a large increase in the budget deficit. But even if the US were to change its tune, it is not clear to me that the other main players in the world economy are ready to act.

Europe seems more interested in a new Louvre, not a new Plaza. The Europeans think the dollar has fallen more than enough, at least against their currencies. They would not mind a bit of dollar appreciation/ euro depreciation -- even though there is not yet evidence that the dollar’s fall v. the euro has even started to bring about the needed adjustment in the US-eurozone bilateral trade balance, let alone the United States’ global trade balance (in part because the dollar’s fall v. the Euro has not led to rising interest rates -- thank you Asia -- and thus has not slowed US consumption/ investment growth). Many Europeans remain allergic to monetary stimulus, for reasons that elude me -- more on this at another time. An ECB obsessed about missing its (too rigid) 2% inflation target (2% is both a target and a ceiling -- apparently, inflation should be close to but not over 2% ... ) hardly seems interested in cutting rates to stimulate European demand.

While Europe wants a Louvre, emerging Asia remains reluctant to agree to a Plaza. If Andy Xie’s view is at all typical (and I suspect it is), emerging Asia, and above all China, remains extremely reluctant to change its exchange rate parity. The renminbi-dollar peg has ushered in a golden age for Chinese industry. Even with a weak renminbi, China can now afford to buy IBM’s PC business. So why change? Rather, emerging Asia wants to find ways to cut into its reserve accumulation without changing the basic exchange rate peg. Xie suggests ending favorable tax treatment for Chinese exporters -- makes sense to me, but that alone is not enough. China also rather clearly thinks the US should be doing a bit more to curb its appetite for borrowing -- though, one presumes, not its appetite for Chinese goods (alas, it is hard to reduce one without reducing the other).

Asia economies seem to be looking for ways to keep their current exchange rate regimes and parities while reducing the pace of their reserve accumulation, not considering more fundamental change. A tiny Chinese revaluation or a move to basket peg won’t change the world’s basic dynamic. An Asian Plaza would need to involve a substantal appreciation of Asian currencies, something comparable to the real appreciation of the euro against the dollar over the past couple of years.

No shock, I agree with Steve Roach: there is a strong case for policy coordination, but, as of yet, no appetite on the part of the major economic blocks to adjust their macroeconomic policies (US: fiscal policy, Europe: monetary policy, Asia: exchange rate policy) to support real global rebalancing. The US prefers benign neglect (and more cheap borrowing, as foreign central banks step in to stop benign neglect from becoming a rout) to either a Plaza or a Louvre. Europe wants a Louvre even if the world still needs a Plaza: the US trade and current account deficit looks more likely to widen in 2005 than shrink. Asia is not yet ready to consider a Plaza, even though nothing needs to adjust more dollar’s value relative to a basket of Asian currencies.

Two last notes. First, Morgan Stanley’s year end spectacular on global rebalancing is worth reading, if only to see how Morgan Stanley’s regional/ country economists reponded to Roach’s demand that they lay out what their region/ country could do to support global rebalancing. The most common answer was not very much -- that lends support to Barry Eichengreen’s pessimism in today’s Financial Times. Second, I am going to miss this year’s Buttonwood columnist in the Economist. Buttonwood’s column highlighting the similarities between the US and a hedge fund was a classic. The new Buttonwood could start by highlighting the growing similarities between Asian central banks and macro hedge funds: afterall, Asian central banks are making big, and increasingly leveraged, macro bets on both the dollar and US interest rates ... Not exactly the macro bet I would want to be taking, but a macro bet all the same.