After the collapse of the Bretton Woods system, the US dollar began to fall. What should be done? Some economists proposed to restore the gold standard. European countries also hoped to take the opportunity to expand the influence of their own currencies.
In the 1970s, the collapse of the Bretton Woods system and the subsequent global economic turmoil formed a complex background. In the same year when the system was declared over, the world faced a serious oil crisis, with oil prices soaring three times in just six months. The crisis first hit the Western world, especially European countries, which were forced to deal with soaring oil prices and had no spare energy to promote the internationalization of their own currencies.
Middle Eastern countries have earned huge revenues from their abundant oil exports, but due to their limited consumption demand, they choose to invest excess funds in overseas markets, especially purchasing US dollar assets to maintain stability.
Developing countries, represented by Latin America, have fallen into financial difficulties due to the sharp rise in oil prices. In this context, only the United States has sufficient financial resources and credibility to provide these countries with much-needed financing.
These situations also show the strong position and influence of the US dollar in the international economy.
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The United States also faces its own problems, mainly high inflation. Presidents Nixon and Ford adopted quantitative easing policies in an attempt to stimulate economic recovery. The policy did not produce the expected results, but instead led to a phenomenon of "stagflation" with high inflation and low growth. The exchange rate of the US dollar against foreign currencies also continued to fall, reflecting the challenges and uncertainties facing the US economy.
In 1979, facing economic difficulties, President Carter decided to appoint Volcker as the chairman of the Federal Reserve. The reform presided over by Volcker was called the "Volcker shock", which adopted the method of tightening the money supply to control inflation.
Although the austerity policy caused economic discomfort in the early stage, led to the closure of some enterprises and farms, and even triggered some strong opposition from the public, these measures began to show results. In the summer of 1982, US prices began to be effectively controlled, the unemployment rate began to decline, and the economy gradually resumed growth. During his term, the United States experienced several years of economic recovery, with the GDP growth rate in 1984 reaching 7.2%, the highest level since 1950.
Through the reforms, the dollar regained strength, currency markets were stabilized, and the foundation for global economic stability in the coming decades was laid.
Starting in 1980, the interest rates on time deposits and loans were significantly increased to encourage people to save rather than consume, and strict conditions were set for banks to lend. These measures caused the interest rates of US commercial banks to soar to unprecedented highs, such as a shocking 21% interest rate.
This nationwide austerity policy triggered a wave of farm and small business bankruptcies, and even farmers drove tractors into Washington, intending to rob the Federal Reserve building. However, despite the pain, the positive effects also emerged after 21 months. By the summer of 1982, the United States had successfully controlled the momentum of rising prices and the unemployment rate began to fall. After that, the money supply was relaxed in a timely manner, which brought the US economy to a seven-year "small spring". In particular, in 1984, the US GDP growth rate reached 7.2%, becoming the most eye-catching growth data since 1950.
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The contraction of money supply prompted the recovery of the US economy and also made the US dollar strong again. From 1980 to 1985, the US dollar index almost doubled. The real exchange rate against the Japanese yen, franc and West German mark rose by more than 40%. During the "stagflation" period, the United States provided a large amount of financing to 12 Latin American countries including Mexico and Brazil. The austerity policy made it difficult for these highly indebted countries to repay their debts. In August 1982, Mexico announced that it was about to default because its debt had risen to 40% of its GDP. The central bank governors of seven developed countries including the United Kingdom and Japan were quickly mobilized to urgently raise a bridge loan of US$1.85 billion to avoid Mexico's bankruptcy. In the following years, Volcker continued to provide active support and strategic advice to Brazil, Argentina and other countries to help them get rid of the shadow of the fiscal crisis.
The Latin American debt crisis may seem to be just a debt problem between developed and poor countries, but it also involves the imbalance of the global monetary system. After the collapse of the Bretton Woods system, a large number of US dollar assets allocated according to the old rules still exist in the market. If the major developed countries do not coordinate the management of these assets, the problem will only get worse.
Since 1973, the pace of economic recovery in the United States and other regions has varied, but official exchange rates between major currencies have not deviated significantly from the levels specified in the Smithsonian Accords. The U.S. dollar’s exchange rate with other currencies, especially the Japanese yen and the West German mark, did not match the actual economic strength of these countries.
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In order to address these challenges, in September 1985, the governments of the United States, Japan, Britain, France and West Germany signed an agreement at the Plaza Hotel in New York, deciding to jointly intervene in the foreign exchange market. This is the famous Plaza Accord.
There is a long-standing theory about the Plaza Accord that it was an "unequal treaty" imposed by the US government in order to weaken Japan's export advantage. It is said that after the agreement came into effect, the yen appreciated sharply, which weakened the cost advantage of Japanese goods, thus triggering the so-called "lost twenty years."
But Toyoo Gyōten, a witness of the Plaza Accord, insisted that the appreciation of the yen was not forced by the United States, but was a voluntary proposal by the Japanese government in line with its economic strategy.
The Plaza Accord was set against the backdrop of an escalating trade war between the United States, Japan, and West Germany. With the dollar overly strong and the U.S. trade deficit widening, the strong dollar had become a burden on the global economy, and a solution needed to be sought.
According to the agreement, the central banks of 10 developed countries including the United States and Japan sold US$10.2 billion in just six weeks, causing the yen to appreciate by more than 20%, and the German mark and franc also appreciated significantly. In February 1987, the signing of the Louvre Accord ended the depreciation of the dollar. This adjustment did not cause serious economic turmoil and was considered a success. In the long run, the Plaza Accord was not a unilateral victory, but a collective decision made by major economies on the premise of recognizing the status of the dollar. It is an important "stabilizer" for maintaining the operation of the world economy.