Too Big a Bang for the Buck

By John Greenwald.

The almighty dollar is causing problems at home and abroad

A country's currency is usually regarded as a symbol of national vitality. A strong currency is seen as a sign of a vibrant, confident country; a weak one is considered an indication that a nation is on the skids. For nearly three years the U.S. dollar has been riding high, perhaps too high and for too long. Now the almighty dollar's very robustness is creating alarm both in the U.S. and abroad. Says Commerce Secretary Malcolm Baldrige: "As the ancient Greeks said, 'An individual's faults are virtues carried to excess.' When the dollar is excessively strong, it hurts our trade and that hurts jobs in the U.S. Too much of a good thing can be bad."

Since 1980 the dollar's surge has been all but relentless. Its value has increased 105% in relation to the French franc, 53% against the West German mark and 50% against the British pound. Now America's currency is about 25% too strong for its own good, according to such experts as C. Fred Bergsten, director of the Institute for International Economics in Washington, and Otto Eckstein, chairman of Massachusetts-based Data Resources.

The toll taken by the strong dollar has been heavy. Some economists believe it has been responsible for the loss of more than 1 million American jobs. Europeans complain that it could cause their prices to spiral upward. Cash-starved developing nations argue that an overvalued dollar undermines their ability to repay huge foreign debts. When world moneymen gathered in Washington last week for the annual meeting of the International Monetary Fund and the World Bank (see box), some financiers feared that the dollar had become a barrier to recovery around the world.

The dollar's current strength is a mirror image of its weakness in the late 1970s, when it sank to new lows against the West German mark, the Swiss franc and the Japanese yen. Then, many of today's problems were reversed. The abject dollar worsened U.S. inflation by raising the price of imports. European leaders angrily charged that the weak American currency made U.S. exports too cheap and was thus hurting the sale of European goods. The failing dollar also encouraged the Organization of Petroleum Exporting Countries to keep jacking up oil prices since member countries were being paid for oil in dollars that were losing value almost daily.

In fact, a number of European fiscal leaders were far more shaken by the feeble dollar than they are by the currency's present strength. A top U.S. financial official met recently with foreign moneymen and asked them bluntly whether they preferred a weak or a strong dollar. The answer: a strong one.

The robust dollar took seed precisely four years ago during the Carter Administration. At the 1979 annual meeting of the IMF in Belgrade, foreign moneymen told Federal Reserve Chairman Paul Volcker that he had to do something to bolster the then sulking American currency. Volcker returned to Washington and three days later unveiled a strategy for curbing U.S. inflation and stopping the dollar's skid. The plan called for the Federal Reserve to keep extraordinarily tight controls over the growth in money, even if that meant sharply higher interest rates.

The resulting spurt in U.S. interest rates has been the mam cause of the dollar's climb. A 90-day U.S. Treasury bill now yields 6.5% after allowing for inflation, for example, compared with 2.7% for a similar French security and 2.8% for one issued by West Germany. Such seductive American rates have attracted cash from all over the world and driven up the dollar's value. In June, foreigners held some $90.9 billion of U.S. Government bonds and notes, up 17% from the same month in 1982.

Even as the Federal Reserve was working to curb money growth and prevent renewed inflation, the Reagan Administration and Congress were generating record federal deficits, which are expected to hover around $200 billion a year far into the future. Says William Baldwin, senior vice president of the National Foreign Trade Council, a lobbying group that represents major exporters: "Virtually every one of our members has recommended that something be done about the budget deficit. We see it as the main problem that is driving up interest rates and making the dollar so attractive."

In addition, foreign investors have been flooding the U.S. with funds to escape conditions ranging from political instability in Latin America to West German uneasiness over the scheduled installation of U.S. Pershing II missiles. "The safe-haven factor has been very important in the flow of capital into this country," says Philip Wellons, an international finance specialist at the Harvard Business School.

The cost of having an expensive currency is high. The overvalued dollar adds about 25% to the price of American exports as varied as coal and computers. "The dollar's incredible value has really proved to be a disaster for U.S. industry," says Economist Eckstein. "The cost has been enormous, and I expect that U.S. economic performance will suffer for several years to come."

The U.S. trade deficit is likely to reach a record $70 billion this year (previous high: $42.7 billion in 1982). It could top a once unthinkable $100 billion in 1984. Although part of that gap reflects slower growth and weak demand in much of the rest of the world, many economists consider the U.S. currency's strength to be the key factor. "The primary reason for our trade deficit," observes Martin Feldstein, chairman of the Council of Economic Advisers, "is undoubtedly the sharp rise in the dollar that has occurred in the past three years."

The widening trade gap has inflicted a heavy toll on American workers whose jobs are tied to exports. The number of such positions declined from 6.2 million to about 5 million between 1980 and 1982, according to a Commerce Department staff report. Commerce estimates that export-related job losses accounted for about 40% of the surge in U.S. unemployment over the 1980-82 period. Bergsten of the Institute for International Economics expects continued worsening of the trade balance to cost as many as 1.5 million more Americans their jobs by the end of next year.

The overvalued U.S. currency has been crippling Caterpillar Tractor (1982 sales: $6.47 billion) in its battle with Japan's Komatsu for leadership of the worldwide earthmoving-equipment industry. Caterpillar Chairman Lee Morgan told a congressional committee that his firm had tried selling machinery at cost to a large buyer in Iraq, simply to win the business. But, recalled Morgan, "Komatsu came in 37% under that, and we lost the deal."

Meanwhile, the woes of exporters are mirrored by the problems of U.S. firms whose products compete with low-priced imports. Says Alfred Eckes, chairman of the U.S. International Trade Commission, which hears complaints of unfair foreign-trade practices: "The growing challenge of imports to domestic industry is a major story. It is as important to this decade as energy was to the 1970s." Foreign-made goods accounted for 12.5% of consumer purchases in the second quarter of 1983, up from 11.4% in 1980 and just 5.8% in 1960.

The harm done by the excessively strong dollar, however, does not stop at American shores. Since oil prices are set in dollars, much of the world has been unable to cash in fully on last March's drop in OPEC's official price from $34 per bbl. to $29 per bbl. Reason: foreign energy users must spend more of their local currencies to buy the dollars needed to pay for oil. Says Edward Yardeni, chief economist for Prudential-Bache: "Europe and Japan have seen no meaningful decline in oil prices."

The dollar is a particularly heavy burden for Latin American countries, which have more than $320 billion of foreign debt. Latin borrowers must convert more of their cheap currency into expensive U.S. money in order to pay the interest on their loans. "The dollar's strength is implicit in our difficulties," says Mailson Nobrega, secretary-general of the Brazilian finance ministry.

The biggest beneficiaries of the dollar's strength have been the Japanese. "They are having a field day," says a senior official of the Geneva-based Economic Commission for Europe. While the expensive American currency raises the prices that Japan must pay for oil and other commodities, it also makes Japanese products enticingly cheap. Japan's exports have therefore been booming. In August, the country piled up a $2.45 billion trade surplus with the rest of the world. The U.S., by contrast, ran an August trade deficit of $7.19 billion.

The bulging Japanese surplus has aroused widespread anger and demands for protection against Japanese goods. Such pressure is one of the most dangerous symptoms of America's robust currency. "The strong dollar does two things," says Commerce Secretary Baldrige. "It weakens our exports and it strengthens imports, and that combination certainly promotes protectionist sentiment. It makes the job of holding the free-trade line more difficult."

While the Reagan Administration continues to espouse free trade, it has already slapped restrictions on a wide range of foreign products. Washington has set quotas on foreign motorcycles and specialty steel, for example, and has persuaded the Japanese to ship fewer cars to the U.S. "We'd really see protectionism if we didn't do that," asserts Baldrige, "because we'd see it legislated by Congress."

Lawmakers are now considering a spate of bills to protect U.S. companies. The most far-reaching is the so-called domestic-content measure, pushed by the United Auto Workers, which would require foreign automakers to include American parts in cars sold in the U.S. Under the bill, which passed the House last December and was reintroduced when the new Congress took office this year, 90% of the content of imports with annual U.S. sales of 900,000 or more would have to be American made.

To be sure, even the present redoubtable dollar has its supporters. Declares Rimmer de Vries, chief international economist for Morgan Guaranty: "The great strength of the dollar is, on balance, good for us and good for the world. Just look at us! We have strong growth, low inflation, a respected dollar. My God, we are doing something right!"

The currency's clout is certainly a joy to U.S. tourists abroad, and it helps keep down the price of imports, from French wine to Japanese television sets. One Reagan Administration official calculates that gains in the dollar's value have shaved an estimated three to four percentage points off the U.S. inflation rate since 1978.

The dollar, moreover, must be strong to fill its role as a global currency. Since some three-quarters of world commerce is conducted in dollars, a vigorous U.S. currency is vital to international economic stability and a growing volume of trade.

The dollar's swing from record lows to record highs during the past few years has led some economists to wonder whether something is wrong with the international exchange-rate system. The current regime of floating rates evolved haphazardly during the 1970s after the collapse of the monetary agreement that the U.S. and its allies worked out in 1944 in Bretton Woods, N.H.

The Bretton Woods arrangements called for countries to establish fixed exchange rates for their currencies. Nations could adjust them only under extreme conditions. In addition, foreign governments could theoretically redeem any dollars they held for gold, which thus served as an underpinning for the system. But these arrangements came apart in 1971, when the Nixon Administration, faced with the possibility that other nations could demand more gold than the U.S. had, stopped exchanging the metal for dollars. Without gold as an anchor, exchange rates began to float freely in 1973.

International moneymen had hoped that the new floating system would enable currencies to find their proper value in relation to one another and would smooth international trade and finance. But the result has been widening gyrations rather than stable, well-aligned rates.

What is now needed, in the view of some experts, is a system that would be more flexible than Bretton Woods and less volatile than the present regime of freely floating rates. One such arrangement was proposed last month by John Williamson, a senior fellow of the Institute for International Economics. It calls for countries to maintain their exchange rates within a range that would be much broader than the limits set by Bretton Woods, but much narrower than the recent wide oscillations of the dollar. Then, if a currency's value got too far out of line, that country would be obliged to take measures like raising or lowering interest rates to get it back within bounds.

Last summer the U.S. joined a four-nation effort that pumped some $3 billion into foreign-exchange markets to buy marks, francs and other currencies in an attempt to stem the dollar's rise. Washington contributed $254 million to that intervention, which was tiny in comparison with the $30 billion Washington marshaled to defend the staggering dollar in 1978. But the intervention, the largest of its kind since then, had little sustained effect, and the dollar is now at approximately the same level it was in early August.

Economists are divided over the future course of the U.S. currency. Most insist that the dollar is unlikely to fall much any time soon. Data Resources' Eckstein expects the dollar to drop at an annual rate of 3% to 4% over the next several years. "Those are small changes," he says. But a few economists predict that the U.S. currency could fall just as rapidly as it has risen. Stephen Maris, former chief economic adviser to the Organization for Economic Cooperation and Development in Paris, warns that when the dollar does drop, it may come crashing down. He believes that the huge American balance of payments deficits could lead to a run on the dollar, perhaps as early as next year. Says he: "The cash can flow out just as easily as it flowed in when the market panics."

The foreign-exchange value of the dollar is more than a narrow concern for economists and speculators. The dollar links U.S. economic policies to individuals as varied as Brazilian coffee growers, German steelmakers and American car buyers. A strong American currency is important for the U.S. and for the world. But today's overvalued dollar is almost as bad as the undervalued one of the late '70s. Moreover, the dollar's wild swings during the past four years point up an underlying weakness of the international monetary system.--By John Greenwald.

Reported by Bernard Baumohl/New York and Gisela Bolte/Washington

With reporting by Bernard Baumohl, Gisela Bolte This file is automatically generated by a robot program, so viewer discretion is required.