The Dollar Crisis: Floating Toward Reform?

MEASURED by the usual signs--the size of the tidal surges of money across national borders, the confusion of tourists caught with currency that no one would take, the tension at the emergency meeting of finance ministers --last week's international monetary crisis was certainly the worst since World War II. Even so, its true gravity could not be gauged by those factors alone. Precipitated by German Economics Minister Karl Schiller in order to get European agreement on new monetary measures, the upheaval at first seemed artificial and contrived. But it quickly became a pointed revolt against the U.S. dollar, the foundation stone of the whole system of Western finance. For the first time, much of the world, in effect, was asking about the dollar the question that arrogant American tourists sometimes ask about other currencies: "How much is that worth in real money?"

Quick Profit. At week's end, a partial answer began to emerge: the dollar will be worth fewer Deutsche marks, and quite likely fewer Dutch guilders, Austrian schillings and Swiss and Belgian francs. At a tense, day-long meeting in Brussels on Saturday, the finance ministers of the six European Common Market nations reluctantly reached a compromise. They authorized member nations to let their currencies "float" --rise or fall in price, depending on supply and demand--within certain limits above or below their stated dollar value. It seemed almost certain that they would promptly rise. This week the West German Cabinet is expected to permit a limited floating of the mark. Belgium, The Netherlands and Austria may well follow that lead; they trade so heavily with Germany that they cannot allow the value of their moneys to get much out of line with that of the mark.

The European ministers minced no words in blaming the U.S. for their di lemma. Said French Finance Minister Valery Giscard d'Estaing: "Europe is having to pay for the U.S. policy of growth and full employment." Schiller was even more direct: "The U.S. deficit of payments can no longer be tolerated with benign neglect."

The monetary crisis began when some remarks by Schiller led money speculators to believe that Germany would soon raise the official value of the mark above its present 27.3-c-. Speculators immediately started selling dollars for marks, hoping to make a quick profit. Contrary to popular opinion, the speculators are not shadowy characters operating on European back streets; most are treasurers of multinational corporations, many American. At any one time they hold huge quantities of various moneys, and they regard it as only prudent to shift funds out of a currency that looks as if it may fall in value into one that seems likely to rise.

Unavoidable Impact. Once the speculation began, it turned into a stampede away from the dollar, and toward not only the mark but every other strong currency in sight. Foreigners poured an unbelievable $1 billion into Germany in a single hour on Wednesday, and exchanged other giant sums of dollars for guilders, schillings and Swiss francs. Even the Japanese yen became a haven. Tokyo commercial banks holding dollars sold $340 million of them to the Bank of Japan for yen on Thursday alone.

By midweek, overcome by the onslaught, the central banks of Germany, The Netherlands, Austria, Belgium and Switzerland decided to suspend all dealings in dollars. That left those countries' citizens free to buy dollars at whatever price they thought the U.S. currency was worth in local money. Amsterdam hotelkeepers, Zurich railway clerks and Bonn bankers either would not accept dollars from U.S. tourists at all or would exchange only limited quantities at discounts as much as 10% below the dollar's official value. Even in Africa the dollar became a species of unwanted funny money. The Bank of Kenya stopped buying dollars with Kenyan shillings, and Nairobi commercial bankers refused to cash traveler's checks for any amount larger than $143.

While European government officials plunged into a round of late-night meetings, Washington maintained an almost eerie air of detached calm. Nixon Administration officials did offer some woefully inadequate help to European countries struggling to stop the deluge of dollars. For example, they proposed to allow any country that had to absorb unwanted dollars to invest them in high interest-bearing Treasury securities. But Washington persisted in describing the crisis as a European problem that the European nations could settle if they wished to simply by marking up their currency values. As Treasury Secretary John Connally told newsmen: "That is a matter for them to decide, as to whether or not they want to revalue."

That attitude represents a misreading of both the depth and nature of the crisis. Floating or outright revaluation of a number of major European currencies may damp down the immediate crisis; presumably speculators will take their profits and clear out. But it cannot solve the basic problem: the weakness of the dollar and the unavoidable impact of that weakness on the international monetary system. The dollar's central role in global finance was established at the Bretton Woods, N.H., monetary conference in 1944, which set up the current international monetary structure. That structure, unfortunately, reflects a world that no longer exists.

At the close of World War II, the U.S. was the only superpower, financially as well as militarily. In particular, it held in Fort Knox 56% of the world's gold. So it seemed only natural that Washington should undertake to anchor the world money system by pledging to buy back, on request, every dollar that flowed out of the U.S. for gold at a fixed price of $35 an ounce. Other nations guaranteed to fix official values for their currencies and to prevent the price of their moneys from varying more than 1% from the fixed value in unofficial trading. Originally, the official values were supposed to be fixed in gold, but they soon came to be quoted in dollars, since the dollar, in what has become a famous cliche of world finance, was thought to be literally as good as gold. The dollar thus became the standard of value against which all other moneys in the non-Communist world are measured.

An End to Awe. The theoretical basis for this dollar dominance has long since been eroded. Decades of U.S. balance of payments deficits (see box) have poured more dollars into foreign nations than the dwindling Treasury gold stock--now below the $ 11 billion mark--can cover. West Germany alone now holds an estimated $20 billion in U.S. dollars, enough to claim every ounce of gold that the U.S. has left, and then some. In fact, though not yet in theory, the dollar has become an international paper currency, backed only by the competitive strength of the U.S. economy.

That change in status has had a profound effect upon the psychology of European financiers, businessmen and government officials, who no longer regard the dollar with awe. It has as yet had no comparable psychological effect in the U.S., which has gone on spewing out dollars through its payments deficits. As the supply of dollars in foreign countries begins to exceed the demand, the price of the dollar in those nations begins to drop. Consequently, the price of the foreign currency, in terms of dollars, rises. In order to prevent prices from fluctuating more than the rules of the system allow, foreign central banks must then buy up the surplus dollars with their own currencies.

Nonpartisan Nonchalance. After a spell of worry about the balance of payments in the 1960s. Washington's attitude has settled into smug nonpartisan complacency. Both Republican and Democratic economists have argued openly that the U.S. need not worry about its international deficits. Government officials have taken the line that any foreign nation unhappy about absorbing dollars can simply increase the official value of its own currency, as Germany did in 1969, thus relieving itself of having to buy up quite so many dollars.

Each foreign revaluation amounts to a partial devaluation of the dollar, which hurts American consumers. If the dollar is worth fewer marks, an American has to pay more dollars to buy beer in Heidelberg or a Volkswagen at home. But revaluations of foreign currencies help U.S. industry, because they lower the price of American goods, expressed in foreign currency, and make them more competitive abroad.

Last week's crisis was a confused European rebellion against this unnatural American dominance, and indeed against the international monetary system itself. The outbreak may prove to be what is required eventually to bring on the long-needed overhaul of the system. But in the short term, it could produce chaos in the world financial community.

Europeans have long resented the U.S. attitude toward its deficits (which Washington officials candidly characterize as "benign neglect"). Piecemeal revaluations repel Europe for the same reasons that they please Washington: they reduce the competitive strength of the revaluing nation's economy. A German revaluation, for instance, raises the price of German goods not only in dollars but in francs, guilders and lire, and makes those goods harder to sell in all markets. The alternative, buying up all dollars that turn up in foreign-exchange offices, infuriates Europeans even more. They complain that they are in effect financing U.S. foreign policies of which they disapprove--above all, the Viet Nam War--and footing the bill for U.S. corporate takeovers of European industry. American military spending and foreign investments swell the U.S. payments deficit, and thus the number of unwanted dollars that foreign nations are required to purchase.

European resentment has turned to alarm over the past year, as the U.S. balance of payments swung from temporary surpluses (by one measure) in 1968 and 1969 to the biggest deficit ever in 1970 (see chart, p. 85). The primary cause of the swing was the decline of interest rates in the U.S. as they rose in Europe, prompting U.S. capital to flow to Europe in search of a higher return. In the European view, the U.S. was now exporting its inflation through the balance of payments deficit. When West Germany's Bundesbank, for instance, buys dollars with marks, it pours money into the German banking system. That money will flow into the spending stream, with inflationary effects, unless the Bundesbank restricts domestic bank lending. While the rate of inflation is subsiding in the U.S., it is rising in Europe. European governments do not see how they can fight inflation effectively if huge U.S. deficits and the operations of the monetary system force them to pump out more money than they judge to be safe.

Karl Schiller has long felt that another German revaluation would be necessary, and has been trying to persuade other European nations to join. Getting nowhere, he seemingly decided to force a crisis. At the start of last week, five German economic institutes released studies; four recommended floating the mark and the fifth institute advocated outright revaluation. Schiller saw the reports before they were announced, realized what their impact would be, and could have used his influence to have them toned down. Instead, he publicly welcomed the reports as "a useful contribution to the debate"--even though he must have known that such a statement would cause speculators to buy marks in expectation of a quick rise in their value.

Showdown in Brussels. Far from unifying Europe on monetary strategy, however. Schiller seems to have produced greater confusion than ever. Even in the midst of crisis, Germany could not win agreement on a concerted European revaluation. After France and other Common Market countries made clear their opposition to revaluation, Schiller's proposal to let the mark float ran into considerable opposition within his own government. At a four-hour meeting in Chancellor Willy Brandt's house in the Venusberg section of Bonn, Foreign Minister Walter Scheel argued that a floating mark would foul up the Common Market's system of farm price supports, which assumes set relationships between the currencies of the Market's six member nations. Bundesbank President Karl Klasen contended that Germany should instead clamp on tight exchange controls in order to stop the inflow of unwanted dollars. The government could, for example, forbid citizens to borrow abroad and order commercial banks not to pay interest on dollar deposits.

Schiller nevertheless won a consensus for his position, and at the Common Market meeting Saturday urged a concerted float by the six nations. The French resisted, largely out of a desire to preserve the Market's farm price-support system; they echoed Bundesbank President Klasen's argument that exchange controls would be preferable. What finally came out was a compromise: Market nations can float their currencies if they feel it essential. But floaters and nonfloaters should try to preserve the rates at which, say, marks and francs can be exchanged for each other, even as the mark's rate against the dollar rises--a goal easier to state than to attain. The Market nations may institute some exchange controls too.

Flouting the Rules. The key question for this week is whether this package will even temporarily stop speculation against the dollar, or merely concentrate it in other currencies--the Swiss franc, for example. Swiss officials have said that they will never float their currency, but that if Germany floats the mark the Swiss franc may be formally revalued. Forced floating or revaluation of one currency after another under crisis conditions could generate growing confusion as to what any currency was worth; it could lead, theoretically, to a paralysis of world trade and investment. In any case, last week's developments begin a de facto revision of the monetary system. Allowing the floating of a few major currencies, such as the mark, guilder and Belgian franc, beyond a 1% variation from their official value openly flouts International Monetary Fund rules.

Thus, even after the current crisis subsides, no patchwork solution is likely to long maintain an international monetary system based on the weakened dollar. The U.S. obviously needs to strengthen its currency, but how can it do so? There are many courses of action open to the Nixon Administration, but several have their own drawbacks.

New Bretton Woods. A sharp cutback in U.S. military operations abroad would reduce the outflow of dollars, but it would frighten some of the very nations that protest American "dollar imperialism"--notably Germany, which feels that the presence of U.S. troops on its soil is necessary until there is a Soviet withdrawal from Eastern Europe. Reinstituting the tight-money policies and high interest rates of 1968 and 1969 would help the balance of payments, but would also abort U.S. recovery from last year's recession and throw many more Americans out of work.

Still, there are actions that would stanch the dollar drain and would be desirable on other grounds as well. An end to the Viet Nam War is the most obvious. Domestically, the Nixon Administration could try to fight inflation by issuing guidelines for acceptable pay and price increases. Europe's moneymen have urged the U.S. to adopt such an "incomes policy," and have lost faith in the dollar partly because of Washington's failure to heed their advice. The Government could also stimulate recovery from recession by cutting taxes rather than relying as heavily as it now does on expanding the money supply and bringing down interest rates.

The U.S., however, is no longer in a position to repair the monetary system by itself. Perhaps the most important lesson of the crisis is that financially, as well as politically and militarily, the days of unchallenged U.S. dominance of the non-Communist world are over. A natural corollary of that development is that the monetary structure should be redesigned to reflect the new reality, and some Europeans did indeed draw that conclusion last week. James Callaghan, former British Chancellor of the Exchequer, for one, in effect called for a second Bretton Woods conference "to build a new system."

At the very least, such a conference could readjust the values of major currencies in a noncrisis atmosphere. It could also make some important technical adjustments in money-trading rules. One might be to widen the fluctuations in currency prices that central banks can permit--perhaps a rise from the present 1% to 5% above or below official value. Flows of speculative money have become so large that the 1% limit has become unrealistic and a breeder of crises instead of a stabilizer.

Even more important, the conference could modify the system so that another currency would share the central role and thus relieve what has become the dollar's crushing burden. Most discussion has centered on a newly created form of money, such as the Special Drawing Rights that the IMF began issuing in 1970 with obviously inadequate effect. There is a more likely candidate: the unified currency that the Common Market nations intend to create, assuming that storms such as last week's crisis do not frustrate their plans. The world needs a second currency that nations could use, along with the dollar, to hold in reserves and settle bills with each other.

Yale Economist Robert Triffin, a leading international financial expert and a member of TIME's Board of Economists, has observed that necessary international monetary reforms come about only as a result of crises. Now that the world has had the crises, it is time for the reform. The chaotic conditions of last week, if prolonged or repeated, pose a grave threat to international stability. The present monetary system served the global economy well for many years and helped to promote an enormous postwar expansion of world trade. But financial institutions, like any other, can stay healthy only if they change with the world around them.

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