Macro Signposts | 20 March 2025

The Challenges of Currency Intervention

The Trump administration's focus on correcting global trade imbalances, coupled with the fact that the real trade-weighted U.S. dollar is now stronger than at any time since the mid-1980s – when the then G-5 (France, West Germany, Japan, the U.K., and the U.S.) coordinated on a currency intervention known as the Plaza Accord – has sparked discussion about the possibility of a new currency accord. Some call this hypothetical intervention the Mar-a-Lago Accord.

While there are similarities between the current situation and the 1980s, key differences may make replicating the past outcome difficult. The Trump administration's efforts to rebalance global trade are constrained by political, economic, and legal factors. Those same factors also likely reduce the near-term feasibility of a currency accord. Engineering a dollar devaluation through intervention alone is a tall task.

Background: why weaken the currency?
The belief underpinning calls to weaken the currency is that a persistently overvalued U.S. dollar – driven by strong demand for the dollar as a reserve currency – has contributed to economic imbalances, particularly in international trade. Specifically, the combination of implicit manufacturing subsidies in trade surplus countries, which have generated excess savings, plus the dollar's use as a safe store of value, has diminished U.S. export competitiveness, weakened the U.S. manufacturing sector, and elevated U.S. consumption.

Based on this logic, policy solutions to correct these imbalances include 1) U.S. fiscal reforms that reduce the U.S.'s reliance on consumption, 2) structural changes in trade surplus economies aimed at increasing consumption and domestic demand, and 3) U.S. dollar devaluation, including tariffs. However, structural reforms face challenging economic, political, and legal constraints.

The Trump administration is simultaneously focused on reducing domestic government spending and on pressuring trade partners through threats of higher tariffs and reduced access to U.S. markets. Generally weak economic conditions abroad have contributed to policy shifts in Germany and China – two trade surplus countries – toward fiscal expansion focused, respectively, on raising spending on defense and consumption. However, other countries do not have the same fiscal space to make similar sized announcements. Further, the U.S.'s own fiscal consolidation faces legal and political constraints that will also be difficult to overcome. Trump administration efforts to reduce the government workforce and dismantle federal agencies have been challenged in the courts and have encountered political pushback. Meanwhile, proposed legislation aimed at cutting spending also faces political constraints – for example, House Republican proposals for large Medicaid cuts would affect Republican districts and states that rely heavily on the program.

Lessons from the Plaza Accord
Amid these constraints, the prospect of currency intervention has emerged. A historical precedent exists: In 1985, the U.S., under President Ronald Reagan, negotiated an agreement with France, West Germany, the U.K., and Japan to intervene in currency markets. It became known as the Plaza Accord (after the New York City hotel where the agreement was signed).

In the years following the Plaza Accord, the real effective trade-weighted U.S. dollar depreciated around 30% peak to trough, and many judged the accord a success. However, a closer look at broader fiscal and monetary policies during this period suggests that the extent of the dollar depreciation likely wasn't fully attributable to currency intervention. Two other factors likely played key roles:

• In contrast to other countries' rates at the time, U.S. interest rates were falling. U.S. inflation peaked at roughly 13% in the early 1980s, and inflation expectations were beginning to moderate, allowing then Federal Reserve Chairman Paul Volcker to aggressively cut rates. From 1984 to 1987, the fed funds rate dropped from a peak of 12% to 6%.
• After Reagan initially cut taxes in the early 1980s, U.S. fiscal policy was focused on consolidation. From 1985 to 1987, the federal budget deficit shrank from roughly 6% of GDP to 3.5% due to large cuts in discretionary spending (including welfare, housing, education, and healthcare programs). In 1985, the Gramm-Rudman-Hollings Act forced deficit reduction through automatic spending cuts if budget targets weren't met. Mandatory spending relative to GDP also marginally declined in the latter half of the decade, after the 1983 Greenspan Commission prompted some Social Security reforms.

Implications for today
Similar to what we saw in 1985, today's real trade-weighted dollar is strong, and the U.S. trade deficit is wide relative to major trading partners and to history. However, several factors could make the currency performance after the 1985 Plaza Accord difficult to replicate today.

• Monetary policy: Similar to what happened in 1985, inflation is moderating. However, after major central banks raised rates in a coordinated fashion a few years ago to combat inflation, they have since lowered them in a relatively coordinated fashion. Furthermore, sticky inflation from tariff-related price adjustments has the potential to delay further Fed rate cuts and stifle the central bank's ability to react to a deterioration in real U.S. growth.
• Fiscal policy: Similar to Reagan administration efforts in 1985, the Trump administration is pushing for deep cuts to government spending, including education, welfare, healthcare, and the federal government workforce. However, differences in the makeup of government spending make achieving a similar improvement in government deficits (a reduction of 2.5 percentage points in the mid-1980s) much more politically difficult today. In the 1980s, government discretionary spending was 10% of GDP; today it's just 6%. Because there's less room to trim, similar levels of fiscal consolidation today would need to include reforms to mandatory spending programs, including Social Security and Medicare, in addition to Medicaid. Such reforms would need bipartisan support and are generally unpopular on both sides of the aisle. This, plus Trump's proposed tax cuts, leads us to believe that U.S. deficits might not get worse, but they aren't going to get a lot better, either.
• Trade policy: President Trump is aggressively raising tariffs. Flexible exchange rate adjustments tend to be the release valve in response to higher tariffs. Because tariffs don't change savings and investment balances, raising tariffs historically has typically resulted in an offsetting strengthening in the currency, leaving domestic economic conditions – including the trade balance – essentially unchanged. The Trump administration's policies have already raised the effective tariff rate by an estimated additional 2.5 percentage points; in contrast, over the 1980s decade the U.S.'s average effective tariff rate was relatively stable at around 3%.
• New trade partners, particularly China: Any effective joint effort to weaken the U.S. dollar would require significant involvement of China and Mexico, neither of which were major players at the time of the Plaza Accord. China in particular seems unlikely to support a joint intervention given ongoing tension and competitiveness between the two powers.
• Key trading partners' reserves of dollar-denominated assets are likely insufficient: The size of interventions is limited by the official reserves of trading partners. Today, U.S. assets are spread worldwide and the share held by key U.S. trading partners is likely not sufficient, especially if China does not join the accord.
• Size of currency markets: The sheer scale of the interventions required to create a meaningful dollar devaluation is staggering. Currency markets today see daily average turnover of some $7.5 trillion, according to the Bank for International Settlements. Even after adjusting for inflation, that's about five times greater than the volume in 1989, in the years after the Plaza Accord.

On balance, a currency intervention is a tall task
Dollar intervention without structural economic reforms would be difficult to achieve. While parallels to the 1980s contribute to calls for another currency accord, important differences limit the feasibility of this type of policy today. For the Trump administration to better balance U.S. trade, structural reforms are necessary. The economic, political, and legal constraints that make structural changes difficult could also constrain the effectiveness of any policy aiming to engineer dollar weakness through intervention alone.

View on the U.S. dollar
At PIMCO, we assess currencies based on cyclical factors (e.g., growth, inflation, and monetary policy expectations of the U.S. relative to other countries), secular factors (e.g., productivity differentials, relative welfare gains), and supersecular factors (e.g., the U.S. dollar's status as the primary global reserve currency, central bank credibility).

These are among many factors that shape the outlook for the U.S. dollar that we will continue to discuss, including at our upcoming Secular Forum in May, when investment professionals will gather to debate the long-term outlook for economies and markets and identify key trends and investment implications. This informed and organized discourse is key to PIMCO's investment process.

Policies that raise uncertainty about the U.S.'s ability to continue delivering strong real welfare gains (per capita real U.S. growth has outpaced other countries for decades, according to World Bank data) could contribute to cyclical dollar underperformance. Higher tariffs should be an offsetting support. It's also important to remember that no viable alternatives to the U.S. dollar as the world's reserve currency are available today, in our view.

In this dynamic macro environment, investors don't necessarily need to take directional dollar views in an effort to seek returns. As one example, PIMCO's investment process has identified structural opportunities in relatively high carry, positive macro momentum currencies versus those with lower yield and deteriorating macro momentum. Focusing on these high carry emerging market currencies could also potentially benefit portfolios in the event that capital flows are redirected away from the U.S.

Overall, we favor carefully managed foreign exchange positions to generate income outside of the U.S. while seeking to minimize correlations to the U.S. dollar or equity markets.

Chiara Massacesi and Thiago Carlos contributed to this piece.

Catch up on recent editions of Macro Signposts:

• Vegetables vs. Dessert Under Trump 2.0: Assessing the Economic Impact of Policy Decisions | 12 March 2025
• Hope and Hype on German and EU Fiscal Reforms | 4 March 2025
  
• Trump's Second Term: Sentiment, Uncertainty, and the Macro Outlook | 26 February 2025
  
• Reciprocal Tariffs: The Trump Administration's New Trade Strategy | 20 February 2025
• U.S. Labor Market Faces Tighter Immigration Policy | 12 February 2025
  

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