The historic 1985 Plaza Accord, signed at the Plaza Hotel in New York City, was a pro-growth agreement signed by what was then known as the G-5 nations: West Germany, France, the United States, Japan and the United Kingdom. The purpose was to force the United States to devalue its currency due to a current account deficit approaching an estimated 3% of GDP according to Paragraph 6 of the accords. More importantly, the European nations and Japan were experiencing enormous current account surpluses as well as negative GDP growth, threatening external trade and GDP growth in their home nations.

Protectionist measures to guard these gains were looming, especially in the United States. Developing nations were in debt and not able to participate in positive trade or positive growth in their home nations, and the United States was forced to realign the exchange rate system due to present imbalances and to promote growth around the world at the expense of its own nation. The Plaza Accord was a growth transfer policy for Europe and Japan that was wholly detrimental to the United States.

Trading Hits a Protectionist Wall
The United States experienced 3% GDP growth during 1983 and 1984 with a current account deficit approaching an estimated 3-3.5% of GDP, while European nations saw a negative GDP growth of -0.7% with huge trade surpluses. The same thing happened to Japan. Trade deficits in general require foreign financing. For the United States during the early to mid '80s, Japan and West Germany were buying United States bonds, notes and bills from their surpluses to finance our current deficits at the expense of their own economies. It was only a matter of time before protectionist policies entered this equation that would not only hurt United States growth at home but force trade wars that would derail the entire system of trade for all nations. (To learn more, check out What Is GDP And Why Is It So Important?)

During this period, inflation was the lowest it has been in 20 years for all nations, and European nations and Japan were investing in their own economies to promote growth. With low inflation and low interest rates, the repayment of debt would be accomplished quite easily. The only aspect missing from these equations was an adjustment in exchange rates rather than an overhaul of the present system.

Global Cooperation
So the world cooperated for the first time by agreeing to revalue the exchange rate system over a two-year period by each nation's central bank intervening in the currency markets. Target rates were agreed to. The United States experienced about a 50% decline in their currency while West Germany, France, the U.K. and Japan saw 50% appreciations. The Japanese yen in September 1985 went from 242 USD/JPY (yen per dollar) to 153 in 1986, a doubling in value for the yen. By 1988, USD/JPY exchange rate was 120. The same thing happened with the German Deutsch mark, French franc and British pound. These revaluations would naturally benefit developing nations such as Korea and Thailand, as well as leading South American nations like Brazil because trade would again flow. (For more, see Forex Currencies: The USD/JPY.)

What gave the Plaza Accord its historic importance was a multitude of firsts. It was the first time central bankers agreed to intervene in the currency markets, the first time the world set target rates, the first time for globalization of economies and the first time each nation agreed to adjust its own economies. Sovereignty was exchanged for globalization.

For example, Germany agreed to tax cuts, the U.K. agreed to reduce its public expenditure and transfer monies to the private sector, while Japan agreed to open its markets to trade, liberalize its internal markets and manage its economy by a true yen exchange rate. All agreed to increase employment. The United States, bearing the brunt of growth, only agreed to devalue its currency. The cooperative aspects of the Plaza Accord were the most important first.

Currency Value - What Does It Mean?
What the Plaza Accord meant for the United States was a devalued currency. United States manufacturers would again become profitable due to favorable exchange rates abroad, an export regimen that became quite profitable. A high U.S. dollar means American producers can't compete at home with cheap imports coming from Japan and European nations because those imports are much cheaper than what American manufacturers can sell according to their profitability arrangements.

An undervalued currency means those same imports would experience higher prices in the United States due to unfavorable exchange rates. What a high dollar means for the United States is low inflation and low interest rates that benefit consumers because they have enough dollars to far exceed prices paid for goods. What the United States agreed to was a transfer of a part of its GDP to Europe and Japan so those economies would experience growth again. And all this was accomplished without fiscal stimulus - only an adjustment of exchange rates. What is understood in the modern day are the harsh effects such devaluations may have on an economy. (For more, see our Inflation Tutorial.)

Japan Feels the Effects
The Japanese felt the worst effects in the longer run of its signing of the Plaza Accord. Cheaper money for the Japanese meant easier access to money along with the Bank of Japan's adoption of cheap money policies such as a lower interest rate, a credit expansion and Japanese companies that moved offshore. The Japanese would later become the world's leading creditor nation of the world. But cheap money policies would later create a slower consumption rate at home, rising land prices and the creation of an asset bubble that would burst years later that led to the period for Japan known as the lost decade.

Japan's recovery today from its lost decade is still very questionable due to the price of its currency. This may be the reason why currency prices today target inflation as a means to gauge growth policies rather than some arbitrary target as was set with the Plaza Accords. (To learn more, see The Lost Decade: Lessons From Japan's Real Estate Crisis.)

Related Articles
  1. Forex Strategies

    These Are The Best Hours To Trade the Euro

    Six popular currency pairs and numerous secondary crosses offer euro traders a wide variety of short- and long-term opportunities.
  2. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  3. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
  4. Investing Basics

    Explaining Trade Liberalization

    Trade liberalization is the process of removing or reducing obstacles that impede the exchange of goods and services between nations.
  5. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  6. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  7. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
  8. Mutual Funds & ETFs

    ETF Analysis: WisdomTree Bloomberg US Dllr Bullish

    Explore an analysis of information on the WisdomTree Bloomberg U.S. Dollar Bullish Fund, a currency ETF that tracks the overall performance of the U.S. dollar.
  9. Stock Analysis

    The Best Stocks to Buy for Less than $10 before Year End

    Learn about the best stocks to buy under $10. These stocks are speculative but have considerable upside given their valuation and market conditions.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI South Africa

    Learn more about the iShares MSCI South Africa fund, which is an NYSE-listed exchange-traded fund offered and managed by BlackRock.
  1. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  2. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
  3. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  4. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  5. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...
  6. Labor Productivity

    A measurement of economic growth of a country. Labor productivity ...
  1. Is Japan an emerging market economy?

    Japan is not an emerging market economy. Emerging market economies are characterized by low per capita incomes, poor infrastructure ... Read Full Answer >>
  2. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
  3. Is Brazil a developed country?

    Brazil is not a developed country. Though it has the largest economy in South America or Central America, Brazil is still ... Read Full Answer >>
  4. Are Social Security payments included in the US GDP calculation?

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP). Transfer Payments For ... Read Full Answer >>
  5. How is the value of a pip determined?

    A pip in foreign exchange trading is a measure of a price movement in a currency pair. "Pip" is an acronym for price interest ... Read Full Answer >>
  6. How are NDFs (non-deliverable forwards) priced

    The price of non-deliverable forward contracts, or NDFs, is commonly based on an interest rate parity formula used to calculate ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!