Deja Vu Trade Conflict - Is this Plaza Accord 2.0?

Trade negotiations between the US and China have so far followed a strikingly similar pattern with the Plaza Accord. In both cases, talks were precipitated by a large bilateral trade imbalance and a perception of an “unfair” advantage, which were exacerbated by new US administration that pursued tax cuts even as the Federal Reserve was in tightening mode.

What is the Plaza Accord? The Plaza Accord was signed by West Germany, France, the US, Japan and UK in 1985 with the purpose to force a devaluation of USD due to US’s current account deficit approaching an estimated 3% of GDP. Over the 5 year period (1985 – 90), the USD dropped almost 50% as the Fed also engaged in a rate cutting cycle and the Accord’s success is widely attributed at least in part to central bank intervention but also to the alignment of monetary and currency policy.

Is History Repeating itself? While unlikely to exactly follow the path of the Plaza Accord and its aftermath, it would not be surprising to see a currency clause inserted within individual bilateral trading agreements with the US that leads to a weaker USD, with the prospects of Fed rate cuts and the growing US twin deficits adding to the negative sentiment.

FX implications

A repeat of the 50% selloff in USD post Plaza Accord is extremely unlikely as it would be difficult for Chinese authorities to manage its economic cycle if it sharply revalues the RMB.

From a valuation standpoint, it is generally accepted that the Yen was exceptionally cheap before the Plaza Accord was implemented. By contrast, CNY may be only slightly undervalued at present levels and Chinese policymakers have already suggested that CNY may weaken instead in the event of a full blown trade war.