Asian Development Bank economist urges big exchange rate deal

By Shamim Adam
Bloomberg News Service
Tuesday, October 3, 2006

http://www.bloomberg.com/apps/news?pid=20601086&sid=aOgjMkgYz91w

SINGAPORE -- Global leaders must find a way to unravel lopsided trade and investment flows or risk a slump in the U.S. dollar that would create havoc for the world economy, Asian Development Bank Chief Economist Ifzal Ali said.

An international agreement along the lines of the 1985 Plaza Accord "on a bigger scale" is needed to unwind the imbalances that have resulted in the U.S. current account deficit swelling to a record $805 billion and surpluses in China, the rest of Asia, and Europe, Ali said in an interview in Tokyo.

"A disorderly unwinding would play havoc not only with the U.S. but with the world economy," said Ali. "What we need is something like the Plaza Accord but on a bigger scale."

A slump in the dollar could prompt U.S. policy makers to raise U.S. interest rates, causing a decline in house prices to accelerate and curbing consumption among the heavily-indebted consumers who represent 70 percent of the world's biggest economy, Ali said. A subsequent slide in corporate investment would have a "chilling" effect on the global economy.

To avoid this, the decline in U.S. aggregate demand has to be as small as possible, growth in Japan and Europe needs to be sustained, consumption has to increase "appreciably" in China, and investment has to go up in Asia, Ali said. A trade accord dismantling barriers to international commerce is also important, he said.

The 1985 Plaza Accord precipitated an appreciation in the yen that eventually led to an asset bubble in Japan that burst in the early 1990s, leading to a 15-year period of lackluster growth during which the world's second-largest economy had three recessions.

"Japan took most of the brunt of the Plaza Accord," said Ali. "Obviously any such agreement needs to be a lot more sophisticated than that."

Ali suggested that countries including China, Brazil, Mexico, India, and Saudi Arabia join the Group of Eight countries to come to an agreement. The G-8 includes the U.S., Japan, the U.K., France, Germany, Italy, Canada, and Russia.

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