Reining In the Runaway Dollar

By John Greenwald

Its record strength delights American tourists, but could choke the recovery

Rolf Sellge, senior vice president of Morgan Guaranty Trust Co., noticed it as a sharp rise in the din outside his office. Traders at the International Monetary Market in Chicago responded to it with arm waving and raucous bids. In financial offices around the world, tensions rose as the news flashed across video screens and was relayed in frantic telephone deals: the price of the U.S. dollar was surging to record levels. The dollar fetched 8.06 French francs at the start of the week, the highest rate in more than 60 years, and also commanded 2.68 deutsche marks, a nine-year high. "The dollar's bandwagon was rolling at such a speed that it seemed that nothing could stop it," said Julian Snyder, editor of a newsletter that follows international money markets.

In fact, a concerted international effort was being mounted in an attempt to stop it. In a break with the free-market principles of the Reagan Administration, the U.S. last week joined France, Japan, Switzerland and West Germany in pumping an estimated $2 billion into foreign-exchange markets in an effort to restrain the rampaging dollar. For most of the previous two years, the Administration had been content to watch as the dollar persistently climbed in value.

While a vigorous currency can be a source of national pride, the dollar's exceptional strength is causing alarm at home as well as abroad. Many experts fear that unless it can be throttled back, the dollar could threaten the recovery from the recession that ended last November. Says Walter Heller, chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson: "The rise in the value of the dollar is putting the world economy on an extremely dangerous course. It has prevented Europe from having a healthy rebound and is placing tremendous pressure on developing countries. For the U.S. it has meant an absolutely miserable performance when it comes to exporting American products."

The dollar has become the world's strongest currency because record federal budget deficits have combined with the Federal Reserve Board's tight money policies to drive up U.S. interest rates. The high rates have then served as a magnet for funds from investors ranging from Japanese manufacturers to Arab oil sheiks. This vast influx of foreign cash, which totals $40 billion so far this year, creates a growing demand for U.S. currency and pushes up its value. Last week U.S. interest rates seemed to be heading higher. The Government reported that July unemployment had tumbled to an annual rate of 9.5%, the lowest level in 13 months. That news, however welcome, is likely to mean a rising demand for credit as newly employed workers head for the stores. In another development, Bane-Texas Group, a Dallas-based holding company with 14 member banks, raised its prime rate to 11% from 10 1/2%. Some experts believe that major banks have delayed similar moves for weeks to avoid jeopardizing a proposed $8.1 billion increase in U.S. assistance to the International Monetary Fund. The House of Representatives last week approved that increase, which had been pushed by the Administration but attacked by critics as a bailout for U.S. banks that made massive loans to developing countries.

Fears of rising interest rates spread through Wall Street late in the week and led to a 14.7-point one-day drop in the stock market. The sell-off appeared to have been triggered in part by predictions of rising credit costs. The Dow Jones industrial average closed last week at 1183.29 after falling nearly 50 points during the preceding ten trading days.

The dollar has drawn added strength from foreign investors seeking a refuge from the uncertainties of their own countries. One leading U.S. banker estimates that wealthy Asians, Africans and Latin Americans have put at least $100 billion into American stocks, bonds, real estate and other investments since 1981.

The migration of funds to the U.S. has created a dilemma for other nations. They must jack up their own interest rates to compete with U.S. levels if they hope to keep the money from departing. But the higher rates will then dampen their economies. "Germany has already let its interest rates drift up since spring," notes Hans Mast, chief economist for Credit Suisse in Zurich. "If American rates don't drop by fall, European rates will have to start moving up." Says Economist Heller: "The international costs and consequences of our interest rates are really incalculable."

The greatest damage has been inflicted on U.S. industries, however: foreign imports have become alluringly cheap and American exports forbiddingly expensive. The result: record U.S. trade gaps that could exceed $60 billion this year and reach a staggering $100 billion in 1984. "Having a $100 billion trade deficit is like suicide," says Otto Eckstein, chairman of Data Resources, a Massachusetts-based economic forecasting firm. "It will mean more plant closings and more unemployment." Data Resources estimates that more than 1 million worker layoffs in the past two years were caused by the strength of the dollar.

The currency's value also has sliced into the profits that U.S. firms make abroad. Their income shrinks when it is translated from cheap foreign currencies into expensive dollars for accounting purposes. Such procedures resulted in trimming the aggregate earnings of U.S. firms by $10 billion in the first quarter of 1983, according to Data Resources.

But muscular dollars also have advantages. American tourists have been enjoying foreign vacations this summer at highly attractive prices because of the purchasing power of their dollars. A night in a moderately priced London hotel currently costs about $67, compared with nearly $90 three years ago. Many travelers are so confident the dollar will continue rising that they have been waiting until they reach their destinations to exchange money.

At home, meanwhile, Americans have been saving on imported goods ranging from French wines to Japanese videotape recorders. A top-of-the-line German camera that cost $1,159 last year now sells for about $950. Experts estimate that the strong dollar has cut some $700 from the sticker price of a new Toyota Corolla. Robert Ortner, chief economist for the Commerce Department, says that the dollar's strength "makes the vast majority of consumers very happy. But they don't have a spokesman."

Cheaper imports have also helped the U.S. control inflation. Wholesale prices dropped at an annual rate of 1% in the first half of 1983, for example, marking the first six-month decline since 1967. Consumer prices climbed just 2.6% over the past year; that twelve-month increase was the smallest in 15 years.

The flood of foreign money into the U.S., moreover, helps to finance the federal deficit because part of the funds go into Government securities. In all, foreign investors now hold $173 billion, or about 15%, of all U.S. Government debt.

The decision to plunge into the foreign-exchange market was made two weeks ago by Treasury Secretary Donald Regan, who is responsible for such transactions. Although he had been predicting a drop in the dollar's value, Regan became alarmed while monitoring the U.S. currency's surge on a desktop computer in his office. He gave the order to intervene quietly on July 29 after talking with Federal Reserve Chairman Paul Volcker and other officials. The U.S. acted with West Germany for one trading day before the other nations joined in last week.

At first, traders hardly noticed the intervention. Foreign-exchange markets swap tens of billions of dollars' worth of currency daily, and the U.S. actions had little impact. "The markets were not impressed," said one European banking official. To get their attention, Washington had to announce formally that it was intervening. That worked briefly, but once the psychological effect of the announcement had worn off, the dollar started climbing again and hit new records at the end of the week.

The joint intervention was the largest since 1979, when the Carter Administration launched a $30 billion effort to prop up what was then a sinking dollar. The Reagan White House, by contrast, has preferred a hands-off policy toward the currency's price. After the attempted presidential assassination in 1981, it stepped in to calm foreign-exchange markets, and it did so again last October, largely to ease jitters over a possible Brazilian default. But each time Washington pumped in no more than $100 million.

The U.S. grudgingly agreed at the Williamsburg economic summit in May to consider more ambitious actions. Under prodding from French President Franc,ois Mitterrand, Washington said it would help stabilize foreign-exchange markets whenever trading became unusually hectic. Some foreign officials, however, had doubted that the Reagan Administration would honor that agreement. Said French Finance Minister Jacques Delors early last week: "The Americans mock Europe and pursue their policies with insensitivity. They only do what's in their own interest."

Most private experts and foreign leaders agree, however, that the U.S. will have to slash the federal budget deficit to well below $200 billion before it can effectively contain its currency. "You simply won't get any change in the dollar until the budget process is brought under control," argues Rimmer de Vries, chief international economist for Morgan Guaranty Trust. The deficit for the coming year is now estimated at $180 billion or so, but it may have to shrink a lot more before any Government intervention will stop the U.S. from serving as a magnet for cash from around the world.

--By John Greenwald.

Reported by Jay Branegan/Washington and Frederick Ungeheuer/New York

With reporting by Jay Branegan, Frederick Ungeheuer This file is automatically generated by a robot program, so viewer discretion is required.