Friday, 31 August 2012

The Allure of Plaza and Louvre

No Country for Old Men
In the 1980s, as the Reagan administration was introducing a new political and economic wave, the Dollar was riding high on the stringent actions of the Federal Reserve led by Paul Volcker. By the mid-1980s, the Dollar was reaching one-to-one parity with the Sterling, leading to frantic calls from Maggie to Ronald to immediately reverse the possibility of the sacred Sterling barrier from being broken.

After having lived through the instability of floating rates in the Interwar years and the asymmetric rigidity of Bretton Woods, following the collapse of the Smithsonian agreement in 1973, was born a Brave New World in finance. A global economy determined by truly floating rates; which itself were supposedly determined by relative macroeconomic factors.

This was far from the truth, the stillbirth of the newly floating Dollar, joined by the other two dominant economies' currencies--Yen and Deutschmark--, needed immediate support. Governments heavily intervened over 1973 and 2004 to determine directly the value of their currencies. In the order of nearly a Trillion Dollars was spent by the U.S., Germany, and Japan, to dirty manage their currencies; a serious misallocation of resources which could have been put towards better use.

It was following Reagan's first term, with the Dollar so high, an immediate need for policy coordination was required. To dream of a concerted bona fide global economic policy in the 1980s was ludicrous let alone to actually have one. Such was the state of play, forty years since World War II, that national legislatures demanded prior approval before they could contemplate a forthcoming global policy coordination--for Bretton Woods had clearly instilled the belief that each nation is for themselves alone.

On the alibi he was going to play golf besides Narita Airport, the then Japanese Finance Minister, Noboru Takeshita flew out on Pan Am, thus also avoiding the hordes of corporates who took Jap Air, to New York in September 1985. Thus was born the Plaza accords, a measure to intervene and bind monetary policy towards a Dollar Depreciation. This was followed two years later with the Louvre Accords to put a floor on the Dollar, from which also the G-7 meetings were born--after the Italian finance minister demanded a piece of the action.

Some blackmailing was required by the U.S. Treasury for the Plaza-Louvre Accords to take place. Ultimately such was the dominance of the American economy and the threat of the Soviet Union that global policy coordination had to take place. This lesson bodes ill-well in a multi-polar world.

Plaza-Louvre were the beginnings of the global imbalances that led to the 2007-08 Financial Crisis. Japan and Germany were more than happy in the 1980s to take in low-yielding U.S. Assets--like Treasury Bonds--and give in return their high-yielding properties, equities, and so forth; thus allowing the U.S. to sustain an indefinite trade deficit. The irony was not missed--Japanese workers made goods for U.S. consumers only to get their pensions securitised by measly low returns from U.S. Bonds.

For the bigger picture: in the future, when the apex of development is reached with a few technological barriers broken and the return to Labour and Capital increased, global finance, dependent on arbitrage, would cease to exist. Exchange rates would reach their Purchasing Power Parity values. And Economics would move on towards Microeconomics--the central influences of psychology and neurology on human behaviour in the marketplace. Or so one hopes.