Hi! So I wrote about Plaza recently here. So this is the background.

So this is a bit of ‘why didn’t X happen?’, which is not easy to answer. Just to iterate, it is easier developing theories of events that happened. In addition, it might be difficult to avoid speculation about events that never occurred such if it wasn’t an option under consideration. I am assuming that ‘printing money’ means essentially increasing the monetary base and any related money multiplier effects. So there are a number different ways to ‘print money’. There is no mainstream literature I am aware of that directly advocates for ‘printing money’ as a countermeasure in regard to such international trade scenario. So this post is going to argue why it wasn’t a good idea, in fact it might even be a bad idea. Thus this is a partly an economic and policy argument as much as it is a historical argument.

First, the Federal Reserve does not concern itself too much with exchange rates, or at least in its official mandates. Second, increasing the monetary base might not be palatable if it causes inflation. In addition, it is not so easy to deploy such policy or policy changes in this case based on what was historically occurring. Third, even if possible to increase the money supply, it is not guaranteed that other currencies specifically the yen would increase in value. The money supply has more long term effects to exchange rates because it takes time for money to get through the system and also depends on trade flows. Fourth, how to sell this to Congress and how is ‘printing money’ in fact dealing with the actual problem of protectionism and trade friction manifested in unemployment, deindustrialization, and loss of trade competitiveness?

The US Federal Reserve’s mandates would have had to be changed. See here. The mandates of the bank are first to maintain price stability and second maximum employment of the labor force. Third, to ‘moderate long term interest rates’. So nothing about devaluing the currency in international markets or balancing trade. So this is contradictory to its mandates and would damage the credibility of the institution if the Fed went rogue. Barring conspiracies, the Fed is a bit secretive until recently, but not opaque. Paul Volcker, the then Fed chairperson, does not seem the type to just go rogue especially after years of fighting inflation. The Fed maintains its independence and sticks to its function, and there are mechanisms to discipline the Fed. This would be rogue activism and it wouldn’t be easy to convince the other members. So they wouldn’t just turn on the printers on a whim nor was it possible to. Monetary banking is very technical. In order to increase the monetary base they would have to lower interest rates or use some other policy tools in coordination with fiscal policy without the market noticing something. This is grossly simplified. So barring if this is even possible to change mandates, this likely might not have an immediate effect especially something very direct in the currency markets. If anything, it is a very indirect effect that take months or years to properly show an effect in the exchange rate data even at all. However, there could be structural effects like inflation that could be unwanted. Such the next point.

The US was just finishing or even still fighting inflation by 1985. See here for the US inflation rate from 1975 - 1990. So the inflation rate of about 4 percent was still high. So generally an economy doesn’t want to allow inflation to be higher than their GDP growth rate. So inflation deflates real GDP growth. The US growing at levels roughly equivalent levels to inflation means that growth was not strong in real terms. So printing more money would mean increasing the risk of further inflation eating up GDP growth. What if the US economy goes back into stagflation where inflation over takes GDP growth and causes more issues? The US abandoning policy against inflation without essentially destabilizing itself might be imprudent at that point. It was a peculiar situation in the 1980s that as budget deficits increased, and further issuance of debt (ie bonds, which create money with the interest), the dollar didn’t naturally devalue. See the Reagan tax cuts. So there was a lot of dollars already circulating. In addition even during the stagflation years, while the US economy was in recessionary levels, the other currencies were also weak. There is not very good consensus why, but one explanation is that foreigners bought US assets like treasury bonds due to high interest rates and general dollar stability. So the overall point might be that it would not directly affect the exchange rates, therefore what if it didn’t continue affecting exchange rates given the immediate history?

So what about the politics? One of the main points for Plaza was to mitigate the domestic political pressure because the Japanese were unfairly trading with the US. Reagan was caught between ideology and de-industrialization. The US trade lobby was applying a lot of pressure on Congress. The US neglected trade and exchange rates until then, but it began becoming very insensitive policy when people were losing jobs and the US loss of its competitiveness. So in addition to continuing to let the Japanese trade rather unfairly in the short-term (considering this wouldn’t be addressed by printing money), the risk of raising prices causing domestic instability seems like a recipe for a political and social disaster in the US. This could destabilize the world economy. If US consumption collapsed and the US went back into stagflation, it could cause a second Great Depression where Congress could have legislated for more aggressive protectionism. As a result of that, it would have caused disruptions in trade and wouldn’t be a good look in the Cold War. Reagan was trying to blunt the pressure against trade liberalization, but further job losses and corporate bankruptcies ie economic chaos due to inflation could effectively tie his hands politically. So it seems rather imprudent to risk destabilize the US itself domestically that would ultimately hurt the capitalist world economy just to change the exchange rates with an indirect mechanism that inflict other damage.