The Winners and Losers from Devaluation
ONCE upon a very recent time, only a banana republic would devalue its money twice within 14 months. But last week, when the U.S. did just that by cutting the value of the once almighty dollar another 10%, the step proved to be both internationally popular and politically easy. In contrast with the four months of testy negotiations that were required to swing the 1971 devaluation, only five days of whirlwind conferences were needed to bring about last week's large and surprising reduction--which made a total slash of 17.9% since December 1971. Foreign moneymen agreed with the U.S. view that cutting the dollar once more was the best way to end what had become a new and virulent world monetary crisis. When the deed had been accomplished, Treasury Secretary George Shultz proclaimed it almost with pride, saying: "There can be no doubt we have achieved a major improvement in the competitive position of American business."
The matter is infinitely more complex, of course, and devaluation will have many momentous effects, both pleasant and painful. Inside the U.S., it should create jobs in businesses that produce goods for export, by making their products cheaper for foreigners to buy. But devaluation will also aggravate American inflation--how badly no one can yet tell--by pushing up the prices of imports. In addition, American travelers will have to spend more on foreign trips; for example, the price of a single room in Tokyo's Hotel Okura last week was $27.75, v. $24 the week before and $22 in late 1971.
By itself, last week's devaluation will not end the persistent tendency of Americans to spend abroad more than they earn. After the 1971 cheapening of the dollar, the U.S. trade deficit more than doubled, to $6.8 billion last year, because devaluation did not lift exports as much as had been expected and the nation's surging economy attracted more and costlier imports. To prevent a repeat, the U.S. is demanding that Japan and the European Common Market nations buy more and sell less in America. President Nixon is making protectionist mercantilist threats about what he may do if they balk.
Acrobats. The dual devaluation of the dollar has hastened the creation of a turbulent new world of money in which the once rigidly fixed values of some currencies are bouncing up and down like acrobats on a trampoline. Since late 1971, for instance, the British pound has risen from $2.49 to $2.64, sunk to an all-time low of $2.32, and last week closed at $2.44. Five important currencies --the pound, Japanese yen, Canadian dollar, Swiss franc and Italian lira--are "floating" with no fixed exchange rate at all. They sell at prices set mostly by supply and demand. That arrangement creates new uncertainty for importers, exporters, investors and tourists, who never know exactly how many dollars will be needed to buy any of these currencies tomorrow.
For all the problems and confusion surrounding it, the second dollar devaluation seems to have been inevitable. The credit for recognizing that fact and meeting it head-on belongs largely to George Pratt Shultz, the mild-mannered but steely-minded professor (see box next page) who plays as dominant a role in the economic policy of the second Nixon Administration as Henry Kissinger does in its diplomatic policy.
Nixon appointed Shultz Treasury Secretary last May and in December made him his economic coordinator, the man to whom all other Administration economic policymakers report. Shultz shaped much of the thinking behind Nixon's hold-the-line budget for fiscal 1974, which aims to reduce the deficit, strengthen the dollar and head.off tax increases by cutting or eliminating many spending programs. His power was fully evident last week, when he ducked out of Alice Roosevelt Longworth's 89th birthday party to announce the devaluation at a hastily assembled 10:30 p.m. press conference. The conference was attended by a pride of Government lions: Federal Reserve Chairman Arthur Burns, Secretary of State William Rogers, Presidential Assistant Peter Flanigan and Council of Economic Advisers Chairman Herbert Stein. They sat around like so many movie extras and let Shultz do all the talking. Even the President had nothing directly to say about the devaluation--perhaps wisely. Nixon had hailed the 1971 Smithsonian agreement, which provided for the first dollar devaluation, as "the most significant monetary agreement in the history of the world." He could hardly have followed up by calling last week's move the most significant monetary agreement in the past 14 months.
In part, Shultz was scrambling to recover one of his own fumbles. Last month he helped mightily to sell Nixon on loosening U.S. wage-price controls, and stressed the shift to voluntary cooperation so enthusiastically as to prompt some inaccurate headlines declaring NIXON SCRAPS CONTROLS. That caused some foreigners to fear a new burst of dollar-weakening U.S. inflation. The fear was rather illogical because the U.S. inflation rate of a bit more than 3% is the lowest among all industrial nations, and the launching of Phase III led economists to add only a fraction of a percentage point to their forecasts of this year's pace of price increases. Shultz says that misunderstandings about the new program "could have been a factor, but not a major one" in igniting the latest money crisis.
Another factor was that Arthur Burns has been jawboning bankers to hold down-interest rates. That helps keep the American economy expanding, but also keeps money pouring out of the U.S. to countries where interest returns are higher. Further, the announcement of last year's staggering $6.8 billion trade deficit confirmed foreign moneymen in the belief that the dollar was still overvalued. The root cause of dollar weakness is that ever since the early 1950s the U.S. has been living beyond its means in the world. Consumers, businessmen, tourists and the Government have been spending tens of billions every year to build factories in Europe, buy Japanese cars and cameras, bask in the Riviera sunshine, dispense foreign aid, station troops round the globe and wage the costly war in Viet Nam.
The spending has sent a huge amount of vagabond greenbacks roaming round the world; nobody is certain of the total, but estimates range from $60 billion to $80 billion. An excess of dollars, like an excess of bacon, drives down the price. The more so in this case as many of the people who hold the dollars have lost faith in their value. The dollar holders note that a long series of U.S. moves--taxes on purchases of foreign securities, for example, and controls on bank lending abroad--have failed to put America's international payments back into balance.
Whenever foreign dollar holders get especially nervous, they can force a crisis by shifting their money into some other currency--usually the Japanese yen or German mark--that they think is strong. If the currency rises in value, they can profit by turning their yen or marks back into more dollars than they had before. In financial demonology, they become evil "money speculators" who are attacking the dollar. Some of these speculators are investors who will put their money wherever they get the highest interest rates. They may sell American bonds, buy marks with the dollars that they get, and purchase German bonds with the marks. Some are the chiefs of the increasingly rich and powerful Middle Eastern oil countries. The most potent are the financial officers of multinational corporations, who do not want to tell stockholders that they lost millions by holding onto dollars that fell in value. Volkswagenwerk is said to have saved as much as $60 million by switching some $500 million from dollars into marks in the summer before the Smithsonian agreement. Businessmen can accomplish much "speculation" by the usually praiseworthy expedient of paying their bills promptly and in full. A U.S. executive buying Japanese structural steel may enclose a check with his order rather than wait until the steel is delivered and the dollar's value may have fallen.
When the speculators move en masse, they create a situation in which all of a sudden everyone wants to sell dollars on the foreign exchange markets. In this manner, some $6 billion flooded into Germany and $1.6 billion into Japan in little more than a week just prior to the devaluation. The government banks in those countries had to buy up the dollars because no one else would purchase them at anything close to their official price. By early last week, it was obvious that something had to give. Even the government banks did not have the resources to keep buying indefinitely at that pace.
In past crises, U.S. officials have tirelessly argued that foreign governments were at fault for keeping the values of their currencies unrealistically low in order to spur exports. This time, though, Nixon had already been contemplating a second dollar devaluation in order to strengthen the U.S. trade and payments balances; even in early January, German officials were picking up hints to that effect. When the flood of dollar-selling burst in Frankfurt and Tokyo, Nixon, Shultz and top White House aides realized that it would be simpler to devalue the dollar rather than try to work out a package of changes in other currencies. A float or upward revaluation of the mark, for instance, would have raised its price not only in dollars but also in francs, pounds and Dutch guilders, playing havoc with the Common Market's plan for monetary union. Also, if the U.S. did not devalue, there was a danger that foreign countries would have put up still more capital controls to keep out unwanted dollars. Germany, for instance, has placed strict controls on bank deposits by foreigners, borrowing abroad by Germans, and new investments in Germany by foreign companies.
To arrange the devaluation, the White House dispatched to Japan and Europe a most conspicuous secret agent: Treasury Under Secretary Paul Volcker, whose gangling figure (6 ft. 7 in.) caused him to be spotted on a street in Bonn when he was supposed to be at his desk in Washington. Though Volcker blew his cover, he accomplished his mission. He ascertained that the most important foreign governments would accept a U.S. devaluation, even though it would make American goods more competitive against their own products, and would not try to cancel the effect by devaluing their own currencies. He told this to Shultz by transoceanic telephone. One night call could be completed only after a secretary had been whisked from her home in Arlington, Va., to Washington by Government limousine to get Shultz's green scrambler telephone out of a safe in his office; she alone remembered the combination. By last Monday, Shultz was able to tell Nixon that the way was clear for devaluation.
For all the battering it has taken, the dollar is still the yardstick against which the values of all other currencies are measured, and a change in its price forces every other government to decide what to do with its own money. By week's end not all those decisions had been made, but this was the situation concerning the dollar's price:
> The dollar dropped 10% against other currencies that did not change their own official price--a powerful group that included the German mark, French franc, Dutch guilder and Soviet ruble.*
> It dropped more than 10% against the Swiss franc and the yen. The Japanese government let the yen float, and late last week its price relative to the dollar had risen nearly 17%--10% because of the devaluation, another 7% because of the float. The yen is now worth 34% more in dollars than before the Smithsonian agreement of 1971. The Swiss franc has floated up 12% in dollars from its last official rate.
> The dollar dropped less than 10% against some currencies that were also devalued last week but by lower amounts than the greenback. Brazil, in a rare show of Latin independence, made a devaluation that leaves the cruzeiro worth 3% more in dollars than at the start of last week. The Italian lira floated down but was worth about 2% more in dollars than before.
> The dollar's price did not change at all against a long list of currencies that were also devalued by 10%. Generally, these were the moneys of nations that are greatly dependent on the U.S. for trade, aid, investment or tourism. Among them: the Mexican peso, Israeli pound, South Korean won and Greek drachma.
The clearest immediate winners in this complex of changes are the speculators, who made an estimated $350 million to $400 million in ten days on their purchases of marks alone. The Soviets will also get an estimated $ 100 million windfall on their grain deal with the U.S. They have about $1 billion in grain orders in the works, and they will now have to pay out less hard currency to buy the dollars that they need to purchase the wheat, corn and soybeans. West Germany won in a way; it avoided an increase in the price of the mark against European currencies. But the Germans paid a heavy price: in order to avoid floating the mark, the Bundesbank had to buy $6 billion of unwanted dollars, which will swell German inflation by expanding the country's money supply. The clearest losers are Japanese exporters, whose goods will become more expensive not only in the U.S. but in every other country as well. Japan, however, will pay less for its vital imports of food and raw materials.
Temptation. Was the U.S. a winner or a loser? Probably a winner, but how big a winner can be answered only as events unfold. For most Americans, the immediate impact of devaluation will be an increase in the prices of foreign goods. Though imports account for only 6.8% of U.S. consumption, foreign raw materials and parts go into countless finished products, and the rise in import costs will put upward pressure on countless prices. U.S. aluminum, for example, is made almost entirely from bauxite imported from Jamaica and Surinam; many coats and suits are tailored from Australian wool; and foreign steel goes into many new American buildings.
This week Volkswagen is expected to boost the price of the basic beetle from $2,059 to more than $2,200. Swiss watches are likely to go up 12% to 25%. Wholesale coffee prices jumped 2 1/2-c- per Ib. last week, and will rise still higher. South African diamonds will go up 10% or more, meaning that lovers who proposed successfully on Valentine's Day can count on digging deeper into their pockets to buy the ring. The price of Chateau Bouscaut 1966, a Bordeaux wine, is expected to rise from $5.49 to $6.29, as are the prices of most European wines. Sam Aaron, president of Sherry-Lehmann, Manhattan's biggest wine dealer, predicts that "there will be a dramatic swing from the much higher-priced French wines to the better wines of California--and that state will not be able to keep up with the demand. One result will be constant increases in the price of California wines."
Much more serious, devaluation may speed the rise in U.S. food prices by shifting more of the output of American farms into export markets, leaving an inadequate supply to satisfy growing domestic demand. Says David W. Brooks, chairman of Gold Kist, a farm cooperative in Atlanta: "American farmers exported nearly $10 billion in 1972, and the total may go to $11 billion or $ 12 billion this year."
Some American manufacturers who have been holding down prices to avoid being undersold by imports may be tempted to mark up their goods if the prices of competing imports rise. Under Phase III guidelines, such increases are not permitted, but they are difficult to spot because U.S. manufacturers no longer have to get advance approval for price hikes.
The brighter side of devaluation is that it is likely to lead to more American jobs. Detroit analysts figure that higher prices should hold sales of foreign cars in the U.S. to 1.6 million this year; had there been no devaluation, the figure would have been 1.7 million. Price increases will also accelerate a decline already under way in steel imports; Derrick L. Brewster, vice president of Chicago's Inland Steel, forecasts that steel imports will fall 20% this year, to about 14 million tons. Result: about 100,000 cars bought by Americans this year will be assembled by workers in Los Angeles or Flint, Mich., rather than in Wolfsburg or Yokohama, and the steel going into those cars will be rolled at mills in Gary, Ind., or Braddock, Pa., instead of Aachen or Kitakyushu.
In classic theory, devaluations should ultimately bring American payments back into balance. But does classic theory really hold any more? All the optimistic predictions being made now, and more, were made for the 1971 devaluation, and they proved to be false.
A major reason is that both U.S. imports and U.S. exports are largely "price-inelastic," meaning that prices have little to do with whether or not they are bought. Among imports, oil is the standout case. The energy shortage is forcing the U.S. to buy more foreign fuel, whatever the cost. Under an agreement between 16 Western oil companies and six Persian Gulf nations, prices are automatically raised to compensate for any significant changes in dollar values. Because of devaluation, the companies, beginning April 1, will pay $730 million more a year in taxes and royalties for Middle Eastern crude. The increase will force price boosts on both heating oil and gasoline for American consumers. Because oil supplies are tight worldwide, the companies' alternative is not to turn to other sources, but to let some households shiver.
Discrimination. Many U.S. exports--jet planes, computers, machine tools--are hightechnology, high-priced items. A foreign manufacturer who needs five computers will buy that many, but he will not increase his order to six no matter how low the price drops. Beyond that, big U.S. manufacturers decided long ago to serve foreign markets by building plants overseas rather than by exporting. The multinational corporations will profit from devaluation. Their foreign earnings will be worth many more dollars than they would have been in 1972. But only the money sent back to the U.S. in dividends will help the balance of payments.
Paradoxically, the short-term effect of devaluation will be to worsen the American trade deficit: more dollars will have to be paid for imports already on order. After that initial impact is past, however, there are reasons to expect that the present devaluation will be more successful than the last. After the first devaluation, quite a few foreign producers were so eager to keep their share of the rich U.S. market that they did not raise their American prices but instead reduced profit margins. Now they do not have much profit left to bite into, and they will have to hike prices. Similarly, some American exports that did not experience an increase in sales after one price reduction may do better after two. Demand for such U.S. exports as coal and farm products is sensitive to prices. Otto Eckstein, a member of TIME'S Board of Economists, forecasts on the basis of computer analysis that the U.S. trade balance will move gradually to a surplus of $2 billion in 1975.
Nixon and his aides argue that devaluation alone will not cure the U.S. payments problem. They contend that American products are blocked out of many foreign markets by discriminatory trade practices. Says Shultz: "Without changes on trade, you can change exchange rates until hell freezes over, and you won't get a thing."
Shultz announced that the Administration will soon introduce a "comprehensive" trade bill that would renew the President's traditional authority to lower U.S. tariffs in return for foreign trade concessions. The bill would also arm Nixon with a dangerous new power to raise tariffs on the goods of countries that deny what Shultz calls "fair access" to American merchandise. Indeed, says Shultz, the bill would permit the President to impose higher tariffs or quotas --or both--on any foreign products that inundate specific U.S. markets.
Nixon gave a notably bellicose ring to these proposals. He had no intention, he said, of just negotiating another round of world tariff cuts. "We have gone into too many negotiations abroad in which all we have done is to negotiate down whereas others have negotiated up," the President said. With Orwellian logic, he added: "In order to get a policy of freer trade, we must always have in the background protection."
Bluster aside, Nixon has a point: the U.S. does face discriminatory trade practices abroad. Tariffs are not the most serious problem; on finished goods, they average 8.5% in Japan and 8% in the Common Market v. 8.4% in the U.S. But the Common Market lavishes on its farmers subsidies that are generous even by U.S. standards, encouraging them to grow food that could be imported more cheaply from the U.S. Beyond that, it maintains a system of variable import taxes that can be adjusted upward to keep the price of American foodstuffs as high as they were before dollar devaluation.
Apprehensive. Japan has been moving to dismantle its once awesome array of protectionist devices, but it still maintains quotas on computers, integrated circuits, leather goods and 24 categories of farm products. Tokyo government officials calculate that the agricultural quotas keep out $460 million worth of potential imports a year. Japanese exporters also get special aid --including low-cost loans and government-paid surveys of foreign markets --that American businessmen consider grossly unfair.
To many foreign officials, however, the new U.S. line on trade sounds like a nationalistic economic offensive. They are especially apprehensive about another move announced by Shultz: phasing out by the end of 1974 of three controls that the U.S. maintains on the movement of U.S. capital abroad. These are the 11 %% tax on Americans' purchases of foreign securities, restrictions on U.S. bank loans to foreigners, and limits on the number of dollars that American companies can send out of the U.S. to build factories overseas. Dropping these controls is a laudable, if somewhat risky step toward greater freedom for the international movement of money. But in the view of some European government officials, the combination of devaluation, tough talk on trade and removal of capital controls suggests that the U.S. aims to build a huge trade surplus that would give American businessmen more money to buy up foreign factories.
Wild as that idea may sound, it is a fair reflection of the heated emotions stirred by trade disputes, which bring up issues of politics, social priorities and national pride. Common Market officials, for example, think that their protectionist agricultural policy is necessary to avoid social disaster; European farmers must be subsidized heavily, they contend, to keep them from leaving the land and jamming into cities. The officials will be extremely reluctant to change that policy for the sake of raising the sales of American farmers.
In dealing with Japan, the U.S. aims at nothing less than a shift in that country's whole economic direction, from overwhelming stress on exports to emphasis on much-needed internal development. Many Japanese would like to see more of their country's resources devoted to building schools, roads and houses rather than to grinding out goods for export, but the conversion will be long and difficult. Meanwhile Japanese government officials and businessmen bitterly resent U.S. criticism of their huge trade surpluses, which they see as the reward for the high productivity and skilled salesmanship that American competitors often lack. Some go so far as to imply that the criticisms are tinged with racism. Trade negotiations consequently will at best be protracted, prickly, and haunted by a constant danger that they will lead not to more freedom for world commerce but to a new outburst of protectionism.
Fortunately, tempers are cooler on the equally important issue of crafting a new world monetary system. Shultz reports that in the wake of the latest financial crisis, foreign moneymen are showing more interest than ever before in lasting monetary reform. They had better; the world right now lacks any coherent monetary system. The old system of fixed values tied to a dollar that in turn was tied to a supposedly "immutable" price in gold was destroyed by the 1971 dollar devaluation. Since then, devaluations, revaluations and floats have been coming with dizzying rapidity. The new flexibility is by no means bad. It enables currency values to change so that they reflect more accurately the international competitive strength of each country. But the world sorely needs some agreed-upon rules for making the changes, so that they will not always be forced by a series of wrenching crises.
Shultz seized the initiative last fall and proposed a detailed plan for a new system. Its main feature: currency changes would be keyed to shifts in the size of the monetary reserves that each nation accumulates in its dealings with the rest of the world. Countries that either persistently lose reserves through excessive spending, like the U.S., or pile up reserves through excessive trade surpluses, like Japan, would be obliged by international agreement to bring their accounts closer to balance. Nations could change their trade practices or could make small devaluations or revaluations as a more or less routine procedure. Shultz also contemplates a lesser role in global finance for the dollar. It would be gradually replaced by Special Drawing Rights ("paper gold") as the major currency that nations use to settle debts among themselves. This would enable the International Monetary Fund, which issues SDRs, to use them to buy up the billions of loose dollars that now slosh disruptively from country to country.
Complaining. The Shultz plan is being discussed by the finance ministers of a committee of 20 nations. In March, the ministers will gather in Washington for the next in a series of meetings that are supposed to produce an outline that could be approved at the IMF meeting in September. But Shultz, in announcing the devaluation, made a point of complaining that the negotiations are going too slowly. Last week he hinted that if agreement is long delayed, the U.S. will act to balance its international payments on its own, presumably by protectionist restrictions on imports or even further devaluations.
Finance ministers of other nations should heed the warning --and the U.S. should temper its emerging nationalist line. It is possible to foresee the second dollar devaluation leading to a strengthening of the U.S. economy, a tearing down of barriers to trade and investment around the globe, and a newly sensible monetary system in which currency values shift frequently but moderately and with little fuss. It is equally possible to envision a world of continuing U.S. deficits, protectionist fences around national economies, and monetary chaos that would strangle the international movements of money, people and goods. Money markets move so swiftly nowadays that the governments of the world's rich nations must act quickly to bring the first vision into being--or risk suffering the second by default.
*Figured another way, the price of these currencies in dollars has risen a little more than 11.1%. By a peculiarity of mathematics, a German, for example, will have to pay 10% fewer marks to buy a given number of dollars, but an American will have to shell out 11.1% more dollars to buy a given number of marks. The reason before devaluation, the mark's exchange rate was 3.2225 to the dollar, and it is now 2.9003; 2.9003 is 10% less than 3.2225, but 3.2225 is 11.1% or so more than 2.9003.
This file is automatically generated by a robot program, so reader's discretion is required.