Plaza Accord: A Bargain for the Strong Dollar and the Birth of a Bubble Economy

In the autumn of 1985, tension filled the Plaza Hotel in Manhattan, New York. At the time, major developed countries including the United States and Japan were facing hidden tensions due to trade deficits and exchange rate issues. The Plaza Accord was a historical meeting aimed at resolving these tensions. The strong U.S. dollar was weakening American manufacturing competitiveness, while Japan and other countries thrived on massive trade surpluses, albeit under pressure from the U.S. Amidst these complexities, the world's five leading economic powers gathered at the Plaza Hotel in September 1985 to make an unprecedented decision. This decision significantly influenced the international economic order and notably marked the beginning of Japan's bubble economy era.

The Super-Strong Dollar and Trade Imbalances of the 1980s

In the early 1980s, the value of the U.S. dollar surged sharply. High-interest rate policies enacted by the Federal Reserve to control rampant inflation from the 1970s drew global funds into the U.S. This strong dollar made American products less competitive, rapidly worsening the U.S. trade deficit. Conversely, Japan and West Germany experienced booming exports and massive trade surpluses with the U.S., foreshadowing their economic bubbles. The Reagan administration, facing the notorious "twin deficits" (massive fiscal and trade deficits), felt a deepening crisis. American industries did not remain idle; manufacturing workers expressed anger by publicly destroying Japanese cars. Discussions in the U.S. Congress about retaliatory trade measures threatened to spark a cycle of protectionism.

Amid this crisis, adjusting exchange rates emerged as a viable solution to trade imbalances. The U.S. considered directly lowering the dollar's value by cutting interest rates, but sudden monetary policy shifts risked market instability. Furthermore, the strong dollar benefited Wall Street financial interests, complicating any policy shift. Eventually, the idea emerged to systematically lower the dollar's value through coordinated international intervention. U.S. Treasury Secretary James Baker convinced major trading partners, ultimately bringing together the so-called G5 countries (U.S., Japan, West Germany, U.K., France).

The Accord at the Plaza Hotel

On September 22, 1985, finance ministers and central bank governors from the U.S., Japan, West Germany, the U.K., and France gathered at New York’s Plaza Hotel. Immediately after their meeting, they issued a joint statement outlining their coordinated intervention plan to curb the strong dollar. For the U.S., this was the realization of the goal to "orderly depreciate the appreciated dollar," while other countries committed to rebalancing trade. The joint statement succinctly announced their agreement to intervene collectively in foreign exchange markets to stabilize exchange rates. Simply put, they declared their intent to lower the dollar’s value and elevate the Japanese yen and German mark.

The accord also included commitments to adjust domestic economic policies. The U.S. promised to reduce its enormous budget deficit, while Japan and West Germany pledged to stimulate domestic demand to reduce their trade surpluses with the U.S. The five governments agreed to directly intervene by selling dollars and buying yen and marks. Unlike typical secretive market interventions, this agreement was uniquely announced publicly, signaling a clear market direction.

In September 1985, G5 finance ministers lined up after announcing the agreement at the Plaza Hotel. From left: Gerhard Stoltenberg (West Germany), Pierre Bérégovoy (France), James A. Baker (U.S.), Nigel Lawson (U.K.), and Noboru Takeshita (Japan). Their unprecedented joint intervention marked a turning point against the strong-dollar policy.

Effects were immediate. Markets responded by selling the dollar and buying yen. Within two years post-accord, the dollar dropped approximately 30% against major currencies. Particularly, the yen surged from around 240 yen per dollar before the accord to nearly 120 yen afterward. Coordinated intervention by the U.S. Treasury and various central banks successfully stabilized target exchange rates. Consequently, U.S. trade deficits improved significantly over time, even turning into temporary surpluses by the early 1990s. Thus, the primary goal of trade imbalance reduction was partly achieved.

However, not all problems were resolved. The anticipated decrease in the U.S. trade deficit with Japan was slower than expected. Structural barriers in the Japanese market limited the effectiveness of currency adjustments, restricting increased exports from the U.S. Nonetheless, the Plaza Accord received credit for temporarily easing trade tensions through international cooperation. Aggressive protectionist measures proposed in the U.S. Congress subsided, and the currency war appeared momentarily resolved.

Japan’s Bubble Economy and Changes in the International Order

Ironically, the greatest impact from the Plaza Accord hit Japan hardest. The rapid appreciation of the yen severely damaged Japan’s export industries, triggering fears of an “endaka recession” (high yen recession). In response, the Japanese government quickly initiated stimulus measures. The Bank of Japan (BOJ) cut interest rates and increased liquidity, attempting to offset export slowdowns through domestic consumption and asset market booms. What followed was unprecedented asset price inflation. In the late 1980s, Tokyo land prices soared, and the Nikkei stock index skyrocketed. The index rose from about 10,000 points around 1985 to nearly 40,000 points in 1989, before crashing spectacularly in the early 1990s.

Annual year-end Nikkei 225 index trends. After the 1985 Plaza Accord, low interest rates and a strong yen fueled a bubble in stock prices, peaking in late 1989 before collapsing, leading to Japan's "Lost Decade."

The aftermath was devastating. In the early 1990s, Japan’s financial institutions faced massive bad debts, plunging the economy into prolonged stagnation. Many analysts link Japan’s infamous “Lost Decade” directly to the yen appreciation and subsequent bubble burst triggered by the Plaza Accord. West Germany experienced different outcomes, successfully stabilizing its currency and smoothly transitioning to reunification without similar economic bubbles.

Interestingly, emerging economies like South Korea benefited indirectly. The yen appreciation improved the competitiveness of Korean products. Combined with falling oil prices, low interest rates, and the 1988 Seoul Olympics, Korea experienced unprecedented export-led prosperity, known as the “Three Lows Boom” (low interest rates, low oil prices, low dollar).

Conclusion: The Pros and Cons of International Cooperation

The Plaza Accord symbolizes a rare instance of coordinated economic cooperation during the Cold War era. The agreement partially succeeded in curbing the strong dollar, reducing U.S. trade deficits, and stabilizing exchange rates. However, it inadvertently triggered Japan’s bubble economy and subsequent crash, demonstrating the double-edged sword of international economic cooperation. This event highlights the interconnected nature of the global economic order, where actions intended to benefit one country can inadvertently burden others.

Even nearly four decades later, the Plaza Accord continues to resonate whenever currency tensions arise, illustrating both the power and limits of international cooperation. This historic agreement remains a critical lesson in international economics.