Despite European efforts to shore it up, the falling U.S. dollar continues to break through their artificial barriers like water seeping through a leaky dam.
A year after the top five industrial nations agreed to bring the greenback`s value down, it has fallen to a level that is making Europe and Japan uncomfortable and worldwide financial markets highly jittery.
And here at home, it has yet to work its intended magic. While the nation`s $170 billion trade deficit may have peaked as a result of the currency flip-flop, analysts agree that a substantial reduction will take years.
In the meantime, new questions are being raised about the wisdom of the Reagan administration`s drive-the-dollar-down strategy. Many believe it ultimately could bring on a worldwide recession if it is not accompanied by a big cut in the U.S. budget deficit and a pickup in economic growth in Europe and Japan.
The administration does not believe a recession risk is great. One senior official noted that the dollar decline has been slow and orderly and that, in spite of fears elsewhere, the conditions do not appear to exist for a precipitous dollar drop that could bring on a serious world downturn.
Yet such worries are expressed in several dimensions. One is the difficulty of transforming the deep-seated foundations of foreign economies by forcing them to sell their goods to the U.S. at a more expensive price–which is essentially what a lower dollar means.
”I have this perverse feeling that a lower dollar might actually be deflationary,” said Edward Yardeni, chief economist at Prudential-Bache Securities in New York. ”It depresses the economies of Japan and Europe.”
He said both economies are structured to import raw materials, convert them into manufactured goods and export them to the rest of the world. To try to change that quickly with a competitive devaluation of the dollar isn`t realistic, he added.
”We`re asking them to create a whole new generation of Yuppies,”
Yardeni said, referring to the young professionals who have led a spending boom in the United States. The aim of a lower dollar is to discourage the buy- happy generation from acquiring so many imports, pushing up the trade deficit. ”But driving the dollar down is not going to solve that,” said Yardeni. ”We`ve got the Yuppies. They`ve got the goods. The American Yuppie is the engine of growth for the world economy.”
Behind this comment is an often-forgotten reality in the dollar debate
–the surplus of goods around the world. This overcapacity, the result of efficient new production facilities in many newly developed countries, introduces a keen new competitive factor into the picture that offsets the impact of a dollar devaluation.
Scott Pardee, vice president of Yamaichi Securities (America), a Japanese government securities firm, said that rather than raise their prices to reflect a lower dollar, some Japanese firms have cut their profits by 30 to 40 percent instead.
The same kind of price restraint is seen everywhere. Nations that were able to penetrate the U.S. market when the dollar was strong during President Reagan`s first term will not give up their sales so easily. Better to preserve some exports than have none at all is the name of the game. This strategy, though, depresses economic growth in the countries involved.
”This is the way markets work in this new era of international markets,” Pardee noted.
The source of exports to the U.S. can shift rapidly. When the yen becomes too strong, noted Yardeni, ”instead of importing video cassette recorders from Japan, we import them from South Korea.” Korea is one of several exporting countries that tie their currency to the dollar. When the U.S. dollar goes down, so does theirs. Thus the price of their exports does not change.
The U.S. wants West Germany and Japan to become the new locomotives for world growth. A lower dollar is supposed to put pressure on them to do just that. Then they will, it is hoped, become the world`s consumers, absorbing more of their own production and more of the U.S.`s, too. Since its peak in February, 1985, the dollar has dropped by 48 percent against the currencies of other major industrial nations.
Although West Germany and Japan have adopted fiscal packages to expand their economies, U.S. officials are adopting a wait-and-see attitude. In Germany`s case, they believe growth will be too slow in 1987. In Japan`s case, they want a pickup now.
The administration official said European efforts to shore up the dollar have not been effective. One reason for the intervention is that European currencies have gotten out of line with each other, he said.
It is not just in the trade area that the lower-dollar strategy poses recession risks. From a straight financial standpoint, it stands there as a potential disturber of a dangerous status quo.
The United States has become a debt junkie. To finance the trade deficit, it borrowed readily available funds from abroad. Japan and Europe so far have been perfectly happy to lend, as long as it`s paid back in interest.
Without this flow of foreign funds, estimated at $150 billion a year, economists say there would not be enough savings in the U.S. to keep the recovery going. If the flow ever were to diminish significantly at a time when the dollar is low, that would mean deep trouble for the U.S. economy.
Interest rates would rise, tending to slow the economy. The Federal Reserve Board would be reluctant to pump out significant new amounts of money to offset this jump in interest rates, fearing a complete flight from the dollar by foreign investors.
Stephen Marris, an economist for the Institute for International Economics, put it this way in a publication entitled, ”Deficits and the Dollar: The U.S. Economy at Risk”:
”Without faster growth in Europe and Japan, the dollar will have to go a lot farther down to stop the United States from going further into debt by the end of the decade. But with the dollar going on down, foreigners will incur further heavy exchange rate losses on their dollar investments.”
The fear: The time will come when foreign investors will give up on the U.S. as a good investment risk. If so, he said, this will cause a ”crunch”
in America`s financial markets, resulting in a deep economic downturn.
In theory, higher interest rates in the U.S. would continue to attract foreign investment funds. But Pardee said that if the dollar is falling at the same time, investors change their mind and say, ”Thank you, sir, but I`m going to wait. A lower dollar has a very chilling effect on foreign investors.”
During two highly stressful days in August, interest rates rose at the same time the dollar fell. Had this trend continued, it soon would have resulted in a massive loss of confidence, many economists feel.
The administration official said while the concern about a dollar-induced recession always is present, ”I don`t think it has any more credibility now than it ever did.” He said the U.S. economy is still growing, inflation is under control and Congress is on the road to taming the budget deficit. In addition, the U.S. still is regarded as a safe haven for investment, he said. One reason other nations might lose confidence in the dollar is the mountain-like amount of U.S. debt, according to economists. Two years ago, the U.S. had no net external indebtedness. At the end of this year, it will rise to $250 billion. According to some estimates, it could reach $1 trillion early in the 1990s.
Marris said if the dollar is to be pushed lower, it must be combined with a credible plan to slash the federal budget deficit and with agreement by Germany and Japan to expand their economies. It will take all three to do the job and prevent the risk of a recession, he said.
Treasury Secretary James Baker tried valiantly to persuade the other industrial countries to pick up the burden of stronger economic growth during the annual International Monetary Fund and World Bank meetings two weeks ago, but he was rebuffed.
Reluctantly, the administration found itself with only one strategy: To let the dollar fall as low it as will, in hopes that the other industrial countries will wake up.
By all rights, they should. According to Marris, neither the Germans nor the Japanese are willing to concede that a ”growth gap” occurred during the 1980s.
”From 1982 to 1985, domestic demand (for goods and services) in the United States rose by as much as 18 percent, sucking in imports from all over the world, while domestic demand rose by only 9 percent in Japan and as little as 5 percent in Germany over those three years,” he said.
In other words, Europe and Japan owe the U.S. one.
Baker`s ace in the hole is to bring Europe and Japan to their senses with a new system of economic coordination. Under this proposal still in the formative stages, the countries would sit down and write down their economic growth targets. Then they would discuss it among themselves and try to reconcile their growth targets one to another. The hope is that peer pressure will bring the Europeans and the Japanese to realize the error of their ways. The Europeans and the Japanese have a counterargument that cuts the Reagan administration to the quick. In spite of its efforts, the U.S. still has a $200 billion-plus budget deficit that directly creates the need for all this foreign money. If this deficit were reduced substantially, they argue, America would be able to live off funds generated at home.
The deficit is being cut, but not very fast. And as the dollar continues to sink, the risks to the world economy grow.
