Greenbacks Under the Gun

As the buck dropped and bullion soared, the Administration talked action

Trying to cope with the worst dollar disaster yet, the Carter Administration last week seemed in peril of following what has become a distressingly familiar pattern: a portentous roll of publicity drums that builds up to a toot on an uncertain trumpet. Early in the week the dollar came under a concentrated cannonade from some financial Guns of August, and its steady, summer-long retreat turned into a disorderly rout. It fell 4 1/2% against the Swiss franc in a single day, while the price of gold, the ultimate refuge for investors worried lest their dollars become worth much less, hit an unheard-of $215.90 an ounce. So the White House passed the word that President Carter was "deeply concerned" and had asked Treasury Secretary W. Michael Blumenthal and Federal Reserve Chairman G. William Miller for advice on what he could do to stop the drop. Then the President called a press conference for Thursday afternoon; the dollar rose briskly, and the price of gold declined, in anticipation of some immediate action.

But when the President appeared before the TV cameras he had nothing new to say. He spoke of his confidence in the U.S.'s "underlying economic strength," expressed hope that a narrowing U.S. trade deficit and a topping out of American inflation this year would eventually strengthen the battered buck--and let it go at that. Even as Carter was speaking, the dollar began sliding again. Though it rose smartly the next day, following an announcement by Blumenthal that there would be "a series of continuing actions" to bolster the dollar in coming weeks, no one could be sure that the decline had been stemmed even temporarily.

Later, the Administration tried to make it clear that it was serious. In background sessions with newsmen, Administration spokesmen outlined a three-pronged program. First, they said, the Federal Reserve Board would be taking steps, in concert with other central banks, to strengthen the greenback, and had already been moving "more actively" in buying dollars to prop up their price. Second, the Administration would step up efforts to get Congress to pass Carter's energy program, which would reduce oil imports and thus stem the drain of dollars out of the U.S. Indeed, Carter personally lobbied House members to work out a compromise to end a fierce dispute over natural gas pricing. Finally, they spoke of both a flat ban on any new federal programs and of cuts in existing ones. The goal: to pare the budget deficit for fiscal 1979 to roughly $40 billion, from the $48.5 billion projected at the start of the summer, as a way of controlling the inflation that is weakening the dollar.

Unfortunately, these efforts can be compared to a statement by a city fire department that it will improve the fireproofing of buildings--without saying what it will do to put out the four-alarm blaze that is raging right now. And if the dollar's fall is not stopped, the U.S. and world economies will be in mounting danger. The cheapening of the greenback may add 1/4% to 1 1/2% to this year's U.S. inflation rate. It both raises the costs of imports, which are now about equal to 10% of the gross national product, and moves American manufacturers to increase prices on goods that compete against imports.

As the currencies of Japan and the West European countries rise against the dollar, the products of these countries become more expensive and harder to sell in world markets--so their economies are threatened too. At worst, the process, if allowed to continue, would lead to a breakdown of world trade and investment, for businessmen cannot make rational decisions if they do not know what the major trading and reserve currency--the dollar--will be worth months or weeks or even days hence. At times last week the dollar swung as much as 1% to 2% in value against some other currencies in an hour or so.

Another threat is a U.S. recession, brought on either by inflation or by dollar-propping actions--primarily a sharp boost in interest rates--that will have to be more drastic the longer they are put off. Top administrative aides privately express concern that the U.S. may be faced with a combination of high inflation and serious recession by the time the 1980 election campaign starts gathering momentum.

What can the U.S. do to prop up the dollar? In the long run, only a drop in the inflation rate (currently about 11%) and a further reduction in the trade deficit will do the trick. But there are some immediate actions that could be taken, though all involve difficulties and risks. The U.S. could:

>Buy up dollars aggressively to support their price, and urge foreign central banks to do the same. The Federal Reserve moved into the currency markets late last week, but the government banks of West Germany, Switzerland and Japan scarcely acted at all. Their position is that they have spent billions in the past to support the dollar, with only momentary success. But they might be persuaded to resume support if the dollar buying were combined with other actions, and the U.S. showed greater willingness to intervene.

>Sell more Treasury gold, and try to persuade other governments to dump some of their hoards. Gold sales by the Treasury and the International Monetary Fund so far have been too small to affect the price much. The world's central banks and the IMF hold 40,000 tons of gold, about half the total ever mined. If a significant amount were thrown onto the market, the price would be knocked down hard, perhaps to $100 an ounce or so. As the dollar gained in value against gold, it might also rise against foreign currencies as well. But central banks are reluctant to part with the one reserve asset they hold that is increasing dramatically in worth.

>Raise interest rates to make dollar investments more attractive. The Federal Reserve moved last week, letting the Fed funds rate (at which banks lend to one another) rise from 7 7/8% to 8%, and increasing the discount rate (at which member banks borrow from the Fed) from 7 1/4% to 7 3/4%. The U.S. could also try to borrow back some of the tens of billions of dollars now held by nervous foreign investors by offering them Treasury bonds paying compellingly high interest. The danger: interest rates high enough to induce investors to give back dollars might also be high enough to tip the U.S. into recession.

>Slap quotas or tariffs on foreign oil to reduce imports. Carter can do this by executive order, and he said last week that he "would not hesitate" to use this power.

No one of these moves would be sufficient to steady up the dollar over the long run, but some combination of them might buttress the buck long enough to permit fundamental market forces to take over. The Carter Administration has long hoped that the dollar's slide would eventually be self-correcting. It would boost U.S. exports by making them cheaper, cut imports by making them more expensive, and thus lower the trade deficit; then the dollar would rise again. There are some signs that the Administration's faith may not be in vain. For example, Japanese imports now account for only 9% of all cars sold in the U.S., down from 14% in January; but their prices have risen so much that the benefit in dollar terms is not readily apparent. The trade deficit declined from a monthly record $4.5 billion in February to a still very high $1.6 billion in June.

Even with a high level of imports, the dollar would be doing better if American exporters were more aggressive in tackling foreign markets. As Assistant Secretary of Commerce Frank Weil told TIME Correspondent William Drozdiak: "U.S. firms have been spoiled with a big market at home and have not felt impelled to sell more abroad."

U.S. inflation has frightened many foreigners into dumping dollars before they lose more purchasing power, but for the moment at least inflation has stopped getting worse; wholesale prices have risen more slowly this summer than they did last spring and winter. And the U.S. economy is strong enough to attract a flood of direct investment in factories and real estate from the very countries whose citizens are also dumping dollars.

Potentially more important, the dollar has become grossly undervalued in terms of its purchasing power vs. that of other currencies, with the possible exception of the Japanese yen. One example: $100, when converted into German marks or Swiss francs, will rent a 'first-class hotel room for a night in Frankfurt or Geneva. In New York City a comparable room in a high-priced hotel costs about $70. In a rational market, the dollar might be expected to rise to reflect its purchasing power more closely.

The trouble is that anyone waiting for rationality in the foreign-exchange and gold markets may have to wait a very long time. Last week's trading was an example: though there was no special news to drive the dollar down, it sank to record lows against the yen, mark and Swiss franc, and also declined against the British pound, which bobbed briefly over $2 for the first time since 1976. Despite the later rally, at week's end the dollar had registered these drops just since mid-July: 7% against the yen, 3.5% against the mark, 10.5% against the Swiss franc, 3% against the pound. Says James Sinclair, a leading Wall Street monetary specialist, expressing a worry widely shared by professional money managers: "The dollar weakness is now feeding on itself, and it could accelerate to a point where it will be impossible to stop its slide."

Perhaps the most menacing sign of loss of faith in the dollar is the wild gold rush that shoved the price of that indestructible metal to a close of $208.50 an ounce last week--up 25% so far this year. The boom has been primarily a dollar phenomenon. The price of gold in yen or marks has changed only slightly. But from Hong Kong to London, gold markets that once were the preserve of diehard fundamentalists are crawling with investors--corporate treasurers, money managers, individual speculators--eager to turn dollars into the metal that has always been a mystical symbol of value.

Much demand is coming from Americans who apparently no longer trust their own currency. Says Gold Trader Joel Goodman of Perera Co. in Manhattan "The whole clientele has changed. I'm now selling to the little investor who wants to protect his savings from the effects of inflation. Money is coming out of bank accounts, stocks and even real estate and going into gold."

The rising demand has collided with a steadily dwindling supply, sending prices rocketing. Though nearly all the gold ever mined (some 80,000 tons) is still around, most of it is either locked away in vaults of central banks or stashed in private hoards. Buyers essentially must bid against each other to purchase newly mined gold--and production in South Africa, the leading mining nation, fell to 700 tons last year, 30% less than in 1970. Moreover, makers of jewelry and industrial products are expected to snap up about 70% of what new gold does become available this year, leaving still less for the goldbugs to fight over.

For South Africa, the rise in price has more than made up for the drop in output. One bank estimates that at an average price of only $190 an ounce in 1978, the nation's export earnings would climb $1 billion over last year, to $4.2 billion. The Soviet Union is the No. 2 gold miner, and last year its Wozchod Bank sold 401 tons at an average price of $150 an ounce, earning a tidy $2 billion. This year Wozchod expects to sell another 400 tons, at much higher profit.

The U.S. for many years has been trying to "demonetize" gold--that is, end its use as a reserve asset--on the reasonable ground that the volume of world trade and investment should not depend on how much of a yellow metal can be dug out of the ground in South Africa. But the price rise is renewing gold's glitter in the eyes of central bankers. Australia, Italy, France and The Netherlands, all financial allies of the U.S., have revalued their gold holdings from the old official rate of $35 an ounce to the prevailing market price, thus multiplying the value of their reserves with the scratch of a pen. The U.S., which has not joined the revaluation trend, still reckons the worth of its 8,516-ton gold hoard at $35 an ounce, or $ 11.5 billion.

Some less developed countries are even more dazzled by gold. To help cover their balance of payments deficits, the IMF gives them dollars or allows them to buy gold at preferential prices. In April, 39 developing countries, including India, Kenya, Mexico, Tanzania and Nepal, demanded the gold instead of dollars. India, indeed, is engaged in what amounts to a gigantic gold speculation: it has started to sell at auction 2.4 million ounces of gold, presumably including the 800,000 ounces that it bought from the IMF in June. The Indians hope to get a better price than the $183 an ounce they paid the IMF, and probably they will.

The Indians, of course, have justification. They must try as hard as they can to pay off the nation's foreign debts--and it is hardly their fault if they can do a better job by turning their dollars into gold, and then back into dollars, than by just using the dollars. But the very fact that such roundabout maneuvers are likely to pay off underlines how urgent it is for the U.S. to stop the dollar's slide.

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