Time for a new US dollar accord

When the dollar last confronted a similar crisis of confidence in 1985 and subsequently in 1987, it resorted to asking for help from some of its fellow G7 members. They gladly obliged and we saw a controlled and managed decline of the dollar under the Plaza and subsequent Lourve agreements. A similar accord could indeed help reduce the current volatility already creating havoc with all trading nations. But is it likely to happen? Ideally it should have been already signed sealed and in execution mode. But alas, it clearly isn't; which unfortunately is more to do with the current state of global politics than economics.

The seminal Plaza accord of 1985 followed by the Lourve in 1987 was a comprehensive agreement amongst than reigning industrial nations consisting of the US, France, Germany (West), Japan, and the UK. It was a melange of fiscal and monetary policies which each country individually agreed to pursue, supported by a concerted currency intervention in the foreign exchange markets. Despite most of them cheating on their undertakings, the accord produced the desired result of a managed devaluation of the US dollar. By 1987 the US dollar had dropped 54 per cent of its value. All in all, the accord produced the required result it intended and saved the world from the consequence of a volatile foreign exchange market.

Tap here to add The Daily Star as a trusted source

Today, regrettably, such an accord may not be so easily forthcoming. The irony is that since Plaza, the world is more economically integrated and globalised and yet there is no sign of any common understanding. Unfortunately the old cabal of the industrial economies that articulated the Plaza accord are not the only ones that matter now -- G7 and G8 members are also not enough -- one has to look at the G20 groupings of countries to find that missing member. It is none other than China.

Difficult as it may be, just for a moment imagine a lunch meeting with the finance ministers representing the old cabal plus China. The undertone of a conversation around the table may flow something like this:

Americans: Look buddies -- we are in desperate trouble with our economy. We need your help to get our budget and current account deficit in order through a managed fall of the dollar. Remember how well we did it together (undue emphasis on the word) in 1985?

Europeans: (murmuring away silently: Since when have we become buddies -- do they think we have forgotten Iraq and the UN debacle?) We understand your predicament. But look, our Euro is already at an all time high of $1.35. Our exports are hurting badly and our economy can hardly be called buoyant. Maybe you should think of cutting your own budget expenditure a bit, especially the ones allocated to unwanted wars.

Chinese: Thank you for inviting us and about time too. I hope you are aware that we are already helping you by funding your budget deficit through our regular purchase of your treasury bonds. We are very sure, our currency peg is the right policy for our economy and we will not be intimidated by anyone to change it. By the by and not exactly unrelated, we may be more accommodating on our currency issues if you are willing to appreciate our one China policy

Japanese: We have our own battle at hand in the domestic economy and therefore have little resources to fight other people's. Our own national debt has escalated to over 150 per cent of our GDP. There are very few macro economic resources left to provide you with any support. However, we do like our current account surpluses, and the yen going below 100 against the dollar will destroy our exporters fat profits.

UK: As you know we are right behind you, old chap! Always willing to oblige. However in this instance we are not sure if our market intervention will make any difference at all; neither can we act as a go-between with the Europeans, they have stopped listening to us since the Iraq incident.

The inevitable undercurrent of acrimonious and opposing views from fellow members of a proposed accord meeting is understandable, given the current mood in global geopolitics. Nevertheless, the key players also understand that the current state of affairs, if left to drag on, could result in a global economic crisis. At its minimum, if this decline of the dollar continues relentlessly, the world could see a sharp rise in US domestic interest rates, to continue attracting foreign investment that is needed to counter the current account deficit. The rise in interest rate is bound to choke the US consumer spending, deflate the real estate bubble, and eventually slow down the global economy which the world can ill afford, including the likely members of the proposed accord.

Notwithstanding all the ill feelings and bad vibes that surround global geopolitics today, there is a compelling and urgent need to sit together and get this correction in global economics right or else everyone suffers. Which is why I think that this will happen sooner rather than later. On balance, everyone realises that if things are going to collapse, than it is better to manage the process than leave it to its own device when matters go out of hand.

The proposed accord could have the result of forcing fiscal discipline on the US, a reflationary policy on Europe and Japan to pick up some of the burden of driving global growth, and a revaluation of the Chinese renminbi and the Japanese yen to take some load off the depreciating US dollar.

If the above understanding is adhered to, even partially, we just might avoid a disaster in 2005.

The author, a former investment banker, is currently managing partner of an independent consulting practice based in Singapore.