What's Behind the Dollar Debacle

By Christopher Byron

Five years have now passed since the world's major industrial nations abandoned fixed exchange rates for the dollar, and the warnings of Cassandras that the end result could be global currency chaos seem uncomfortably close to coming true. Scarcely a week goes by without the once mighty greenback reeling from a fresh thrashing on the money markets; and when it does steady, as it did in Europe last week (see ECONOMY & BUSINESS), no one can trust the stability to last. Though the effects of this beating remain of only peripheral concern to most Americans--unless they travel abroad--the dollar's travails are deeply alarming the U.S.'s allies and trading partners.

While many Americans often view the dollar only as their own national currency, it is also the principal trading and reserve currency for the rest of the world. What the U.S. does or does not do with the dollar affects every country on earth, and Washington's mismanagement of its money has lately begun to seem more and more like a script filled with dire trouble for everyone.

The perils start with the possibility of protectionist measures being taken by nations seeking to isolate themselves from the effects of monetary instability. Then come the threats of a breakdown of world trade --caused partly by protectionism, partly by uncertainty about what exchange rates will be the next day or even the next hour--followed by a speedup in global inflation and, finally, international recession. Relations between Washington and its two most important economic allies, West Germany and Japan, both of which are crucially dependent on exports for economic growth, have already deteriorated alarmingly. But doomsday is not inevitable. For more than three decades the world has looked to Washington for economic leadership, and now it is begging for it--almost desperately. There is no time to lose.

The immediate problem is that there are just too many dollars in foreign hands. Last year the U.S. spent an estimated $19.5 billion more than it received in all "current account" transactions (trade in goods and services, tourist outlays, weapons exports) with foreigners, an abrupt turnaround from two years earlier, when the U.S. racked up a towering $11.6 billion surplus, caused in part by a drop in imports during the recession. The massive swing back into deficit, which began early in 1976 and has accelerated ever since, has added to a pile of dollars owned outside the U.S. that is estimated to total anywhere from $300 billion to $400 billion.

The deeper problem, however, is a loss of worldwide confidence that the U.S. knows how, or even wants, to manage its economy in such a way as to give those dollars any lasting value. That confidence has been eroding for more than a decade now, and restoring it will be no easy matter.

The Carter Administration has not even begun. Instead, its words and actions so far have merely accelerated the erosion of confidence. In the early months of the Administration, Treasury Secretary W. Michael Blumenthal actually tried to talk the then overvalued dollar down, in the hope that a decline in its value would help U.S. exports by making them cheaper. He reaped a phenomenal harvest of bitterness among U.S. allies, who feared damage to their own economies as a result. In West Germany, for example, current mordant humor invokes the World War II Morgenthau Plan to have occupying armies dismantle German industry and turn the nation into an agrarian country; that plan, Germans say, has been reborn as the Blumenthal Plan to accomplish the same result by monetary manipulation.

Lately Washington has begun expressing concern, but most of the Administration's utterances picture the dollar drama as a self-correcting problem. Earlier this month, for example, President Carter patronizingly remarked at a press conference that the slide would stop once money traders realized that the dollar is now cheap enough to make investment in the U.S. attractive.

What he failed to point out then--and in a similar statement at last week's press conference--is that if all those billions in greenbacks now tucked away in foreign hands began circulating through the U.S. economy, inflation could shoot through the roof.

Administration officials also have sent out weak and wavering signals on how far the U.S. is prepared to go in buying unwanted dollars to prop up their price. Washington grudgingly announced in January that it would begin some support buying, touching off an explosive but momentary dollar rally. However, the U.S. has stressed that it intends only to prevent "disorderly" trading, implying to currency dealers that it is still ready to let the dollar sink provided the decline is gradual. Last week the New York Federal Reserve Bank announced that from November through January the U.S. Treasury had spent $1.5 billion in foreign currency on purchases designed to bolster the dollar--a record sum, but too little to steady the dollar or keep markets orderly. Small wonder that foreigners are confused. Says West Germany's influential Frankfurter Allgemeine Zeitung: "What the Americans do with--or let happen to--the dollar is incomprehensible to Europeans. It is, of course, the dollar of the Americans. But it is also the dollar of all of us. People feel left in the lurch by America, the great and admired leading power."

Washington's befuddled statements about the dollar are only part of the trouble. More at issue is how well the U.S. is adjusting to a changed world economy. Oil is the test case. For Americans, it is temptingly easy to blame all the dollar's problems on the Organization of Petroleum Exporting Countries, and the arithmetic is irrefutable. If OPEC had not quintupled oil prices beginning in 1973, the U.S. would not now be paying almost $45 billion a year for imported petroleum; if the oil bill were smaller, the country would not be running a trade deficit of nearly $30 billion a year. There would be fewer dollars for sale on currency exchanges, and the dollar's value would be considerably higher. Unfortunately, making that argument is about as useful as ruminating on how much easier it would be to negotiate with the Soviet Union if it were not ruled by Communists. The fact is that the U.S. is now living in a world of expensive fuel, and doing nothing effective either to conserve energy or to increase domestic energy output. To foreigners, who are saving energy through higher gasoline prices and self-imposed limitations on oil imports, the U.S. seems determined to consume as much foreign oil as its wasteful habits dictate, whatever the effects on the dollar or its own economy.

There are other tests. Foreign nations once looked to the U.S. as the example of a powerful economy that could grow without serious inflation, a feat attained by few countries. The fact that double-digit inflation could hit the U.S. too, as it did in 1974-75, came as a shock abroad as well as at home. Now overseas observers see the U.S. bragging that its economy is growing at one of the fastest rates in the industrial world, yet whining fearfully that inflation is likely to result. The spectacle is compounded by the nation's refusal either to cut its $61 billion budget deficit (despite Jimmy Carter's pledge to do so) or to institute a tough wage-price policy to cope with the inflation threat.

Worst of all, this picture of a self-indulgent America, blind to the consequences of its economic management, has been steadily hardening since the late 1960s. Until then, the non-Communist world had lived fairly comfortably with a system of currency exchange rates pegged to the dollar, whose value was fixed in gold (at $35 per oz., a price that seems ridiculous today). That system might not have lasted in any case; even in the early 1960s there were worries about American balance of payments deficits and an outflow of gold from the U.S. But Lyndon Johnson put an intolerable strain on the system by fighting a war in Viet Nam without raising taxes early on or cutting domestic spending to pay for it. That policy spurred inflation at home, sucked in imports from abroad, and sent dollars pouring overseas by the billions. Under the rules that then applied, foreign central banks had to buy up any greenbacks that private traders did not want, and this merely spread the inflation disease to the U.S.'s trading partners. Governments everywhere screamed that the U.S. was forcing them to pay indirectly the inflationary price of financing a war that they abhorred, but Washington ignored them.

By 1971 the U.S. could no longer maintain the tottering system, so the Nixon Administration abruptly announced that it would stop redeeming dollars for gold. That left U.S. allies stuck with dollars that were worth only what they would bring on the exchange markets. Two formal dollar devaluations followed, and eventually, five years ago this month, fixed exchange rates were dumped. Throughout this process, the U.S. seemed complacent, even proud. John Connally, who was Treasury Secretary when the gold window slammed shut, boasted that he had acquired a reputation as "a sort of bullyboy on the manicured playing fields of international finance." Nixon's own attitude was immortalized by a casual comment on a Watergate tape: "I don't give a shit about the [Italian] lira."

Though it is obviously unfair to tax the Carter Administration with the sins of its predecessors, there is no escaping the legacy. That legacy is, in fact, a large part of the reason that the transatlantic debate over the dollar has turned into a dialogue of the deaf. Since early last year, Washington has been urging Bonn to expand its economy and bring its growth rate up to the U.S. level. If West Germany did that, its trade surplus would shrink and the deutsche mark would cease its inexorable rise against the dollar. When Administration officials charge that West Germany's refusal to cooperate really amounts to an effort to have things both ways, they have a point. By refusing to pump up its economy, and choosing instead to keep its factories humming as a result of demand from the U.S., Bonn has copped a free ride out of the 1974-75 global recession, and avoided the inflationary risks inherent in stimulating West Germany's own domestic demand.

But Washington's efforts to get Bonn to change its mind and begin sharing some of the burdens of growth have been rendered counterproductive by the way the Carter Administration has wielded the dollar as if it were some sort of international shillelagh. That attitude has merely aroused suspicions in Bonn that Washington is once again trying to push its own inflation off on its friends. Says William Pfaff, associate director of the Hudson Institute Europe consulting firm in Paris: "There is a feeling in Europe that Washington is interested in Europe when it wants something from Europe, and that otherwise Washington has its own problems and doesn't care much." Geneva Banker Nicolas Krul adds: "What we see is a key country simply giving up its role of economic leadership and mismanaging the world's most important reserve currency."

Faced with this unhappy history, what can the Carter Administration do now? The first essential is to have a coherent energy program enacted, and quickly. To that end, the President should make whatever reasonable compromises are necessary to get his energy bill through Congress, even in truncated form (the bill has been in Congress eleven months). He should also let it be known that he is seriously considering supplemental measures -- slapping a stiff tariff on imported oil, for example, if consumption does not come down. The damage done by dawdling on energy can hardly be overstated. Asks Chief Economist Hans Mast, of Switzerland's Credit Suisse Bank: " What are we to think of a President with a parliamentary majority who cannot get his energy program through Congress?"

The Administration must also put together an anti-inflation program that consists of more than constant disavowals of wage-price controls. What that program should be is a legitimate subject for urgent national debate; the very fact of a debate would reassure foreigners that the U.S. is not content just to hope that inflation will go away. Further, Carter might appoint a task force to study ways of increasing U.S. exports, and thus shaving the trade deficit, without trusting to a sinking dollar to do the job. Another useful step would be to ditch the provision of Carter's tax "reform" plan that calls in effect for higher levies on export profits.

Finally, the U.S. should announce, and carry out, a program of aggressively buying up dollars, borrowing all the foreign currency it can from central banks to make the purchases. Such intervention alone would not shore up the dollar for long; it would succeed only if backstopped by effective energy and anti-inflation policies. But it probably is essential to break the psychology of fear that has gripped exchange markets.

Restoring confidence in the dollar will be a long process, but it must be started. Washington's handling of its role as the world's central banker is a matter of both substance and style, and for too long the U.S. has paid only passing attention to how the rest of the world sees its actions from either perspective. The perils of the U.S.'s ignoring its responsibilities go beyond economic stability, vital as that is. Just as war is too important to be left to generals, international finance has become too essential to be entrusted to money traders. If the U.S. cannot develop effective policies to pursue for the health of the world economy, or its own self-interest, can it be trusted as the leader of a Western military or political alliance? Fortunately, no one is yet asking that fundamental question, and Washington had better make sure it does not come up. Today, as always, the American dollar remains the worldwide symbol of the U.S. itself; if the currency is weak and friendless, the nation eventually will be too. -- Christopher Byron

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