Ending Benign Neglect

The U.S. abruptly shucked its year-old policy of "benign neglect" of American currency abroad last week. It did so by permitting the Federal Reserve Board to go into the international money market to help raise the value of the dollar, and by serving notice that it would bolster its currency against further devaluation. This complex maneuver signaled a timely break with former Treasury Secretary John Connally's hard line of economic nationalism and a step by the U.S. toward greater cooperation with its trading partners in seeking to ease world money problems.

These problems center on the dollars that have flooded into foreign countries because of the U.S. balance of payments deficit. Since August the Treasury has refused to dip into its reserves of gold and foreign currencies to buy back foreign-held dollars. Instead, the U.S. has insisted that the European banks should buy dollars with their own currencies. Even though these transactions increased the money supply and aggravated inflation in some European countries, the foreign banks felt obliged to buy the dollars. If they refused, the dollar's value would fall. The real victims would be the Europeans, because their goods would become relatively higher priced--and less competitive--than American goods in export markets.

Swaps. European leaders were increasingly disturbed about the burden of propping up the dollar. Federal Reserve Chairman Arthur Burns argued that for the sake of improving the international monetary climate the U.S. should take part in supporting its currency. Moreover, if the U.S. helped decrease the amount of dollars abroad, foreign governments would feel less need to impose currency controls. (Reason: the controls, which impede international trade and investment, are designed largely to keep dollars out.)

By last week Burns had persuaded both President Nixon and Treasury Secretary George Shultz. The Federal Reserve thereupon bought back an undisclosed amount of dollars on the open money market, purchasing them with German marks taken from the slender American currency reserves. Beyond that, the Federal Reserve made known that it will revive currency "swaps" with other countries. Swaps, which had been common before last August, allow the U.S. to borrow foreign currencies and use them to buy back dollars.

Washington's policy switch had beneficial consequences. The dollar's value rose in world markets. Last December's Smithsonian agreement, which set exchange rates for major currencies, was strengthened. Said Burns: "We want to let the world know that we want to do our part to maintain the Smithsonian agreement."

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