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The 1985 Plaza Accord and What it Means for the US-China Trade War

American author Mark Twain famously wrote, “History doesn’t repeat itself but it often rhymes.” And amid the current US-China trade dispute, markets are having trouble dismissing a familiar feeling from three decades earlier. In Beijing, there is a growing concern, should China concede to Washington’s policy demands, would the second largest economy face a similar fate to Japan during the mid-1980s. Memories of the Plaza Accord remain so painful for policymakers in Tokyo, even Beijing remains nervous.

What was the Plaza Accord?

The Plaza Accord was an agreement in the mid-1980s between the United States and trading partners Japan, Germany, France, and the UK, to depreciate the US dollar after the greenback appreciated roughly 50% between 1980 and 1985. Though five countries were involved, historians quickly point to Japan’s experience as the turning point that led to its lost decade.

With the subsequent rapid yen appreciation, the Bank of Japan (BOJ) responded by cutting interest rates aggressively. While the liquidity injection resulted in higher asset prices, the debt accumulation weighed on future growth potential Deflationary pressures remain evident in Japan, even today.

A Plaza Accord with “Chinese characteristics”?

Like its experience with Japan, Washington is grumbling over the trade deficit with Beijing, as well as demanding greater access to China’s domestic market. Though, there also differences too. At the time of the Plaza Accord, trade disputes fell on the General Agreement on Tariffs and Trade (GATT), which was replaced by the World Trade Organisation (WTO) in 1995. Japan is a military ally, while European trading partners also share the US’s grievances towards China.

Given China’s military might, economic clout, and preference for domestic stability, it becomes more difficult to see Beijing completely acquiescing to US demands. However, Beijing’s new foreign investment laws do act as a preliminary olive branch and early concession.

China might benefit from currency appreciation

In the mid-1980s, an appreciating yen led to a string of bankruptcies for exporters, negatively impacting Japan’s trade-driven economy. While a stronger RMB would also hinder Chinese exporters, the economic dynamics might ironically help Beijing given policymakers’ efforts to rebalance towards internal economic drivers. A stronger RMB would make Chinese assets more desirable to international investors, as well as help overseas projects like the Belt and Road Initiative (BRI).

But an appreciating currency in China would preferably be desired on Beijing’s terms. Similar to Japan, a surge in foreign liquidity could be overwhelming for the People’s Bank of China (PBOC).  Besides the costs to sterilise foreign flows (the costs for central banks to keep stable domestic exchange rates), the surge also inflates asset bubbles, causing investment speculation that is dangerous for economies.

The Beijing lesson

Given markets are unlikely to see the full transition away from China’s state-run economic model, a sustainable truce between Washington and Beijing is also doubtful. What is more likely is the continued reference back to the Plaza Accord, particularly as Beijing continues to increase credit and cut interest rates the way the BOJ did in the late-1980s.

Beijing should learn from the BOJ, which was criticised for being too slow to implement meaningful reform to drive the economy, including facilitating more competition in its state-directed economy.

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