BUSINESS

BUCK PASSING

The U.S. dollar’s rapid decline causes headaches around the world

CARL MOLLINS July 11 1994
BUSINESS

BUCK PASSING

The U.S. dollar’s rapid decline causes headaches around the world

CARL MOLLINS July 11 1994

BUCK PASSING

BUSINESS

The U.S. dollar’s rapid decline causes headaches around the world

CARL MOLLINS

For the 655 million people who live in the world’s seven richest industrial nations, money means buying the better life—a nice home, a new car or, for some recession victims, merely their next meal. For the several thousand currency dealers in major banking capitals around the globe, cash is a commodity, like coffee or zinc, to be bought and sold on fractional shifts in the exchange price of a dollar for marks, the lira for francs or sterling for yen. For the leaders of the seven wealthiest countries, money in either role is often a headache. A currencyexchange dispute amid a recession inspired the first rich-country summit in 1975, when they were six. (Canada joined the United States, Japan,

Britain, Germany, France and Italy the following year.) And last week, as the Group of Seven (G-7) leaders prepared for their 20th annual economic summit in Naples, running from July 8 to 10, turmoil in the currency markets threatened their cautiously laid plans to help their recession-weary citizens buy a better life.

A massive shift of investment funds to the Japanese yen and the German mark at the expense of the U.S. dollar presented the summit with a dilemma over what to do. A week before Italy’s Prime Minister Silvio Berlusconi was to open the summit, a report by the economics department of the Mellon Bank in Pittsburgh reflected widespread speculation by citing “rumors about co-ordi-

REPORT FROM WASHINGTON

nated [interest] rate moves” by G-7 members in an effort to calm currency markets. Failing such an agreement to raise U.S. rates and reduce others—thereby encouraging a return flow of funds into American dollar securities—the summit leaders seemed ready to offer little more than a pledge to stand by a plan proclaimed at last summer’s summit in Tokyo and repeated at a G-7 jobcreation conference at Detroit in March: the pursuit of stable recovery programs that avoid, at all costs, causing inflation.

More direct action has been tried in recent months—unsuccessfully. Twice during a span of eight weeks in May and June, groups

of central banks enlisted by Washington proved powerless to halt the devaluing run against the U.S. dollar by buying dollars and selling yen and marks in currency markets.

The failure of such direct interventions underlines Washington’s waning influence in a new global economic order. The reduced U.S. world role following the end of the Cold War is now accompanied by a diminished status for the American dollar. With free access to international markets, investors can shift vast amounts of money at electronic speed. The currency-exchange markets handle as much money in a day as the U.S. government spends in a year. The volume and volatility of

those cash flows, and the damage they wreak on nations and trade, have prompted some faint calls for regulation. Washington and Paris called for such reforms in the 1970s, but nothing came of that.

The danger of the present currency upheaval, already depressing stock and bond markets, is that it may inhibit the growth of global trade and investment. Putting off corrective action only stimulates a fear of inflation already present in the markets and may ultimately force austerity measures that throttle recovery. However, Scott Clark, senior assistant deputy finance minister and a summit adviser to Prime Minister Jean Chrétien, said that, “interest rates and exchange rates will look after themselves if sound policies are reaffirmed.”

The Canadian position reflects the official view in Washington—that financial markets are defying evidence that inflation-free recovery is under way. As U.S. President Bill Clinton declared on June 22, the day after the U.S. dollar dipped to a postwar record low of less than 100 yen and dropped below 1.60 marks: “This is the first time in 30 years that we have had a growth in the economy with no inflation.” In the end, he added, “the markets will just have to respond to the realities of the American economy.” The markets were unimpressed: within a week, the dollar’s value slid further below the 100-yen marker, a tumble of more than 12 per cent since January.

The American debate over the causes of the dollar’s fall, who is to blame and what to do, covers a wide spectrum of speculation and recrimination alongside earnest analysis. Some commentators argue that

high interest rates and other anti-inflation measures have drained the system of enough money and credit to finance the trade boom. Others maintain that a dollar surplus exists because Washington has printed money to cover annual budget and trade deficits.

Another group of analysts contend that market troubles are driven by uncertainties generated by the debate itself. Others hold that the U.S. economy’s impressive performance is too good to be true. That is especially so among conservatives who mistrust Clinton’s emphasis on generating jobs and on tapping corporate profits and the public purse to provide universal health care. The U.S. gross domestic product, following a heated burst of growth in the fourth quarter of 1993 at an annual rate of 7.5 per cent, moderated to a 3.4-per-cent growth rate in the first quarter this year. Unemployment fell to six per cent of the labor force in May from 6.4 per cent in April. Tax revenue surged, and the current federal deficit is plunging below official forecasts.

Still, many economists, some government advisers and much of the financial community are clearly convinced that the powerful recovery, and Clinton’s plans, carry the seeds of wage-and-price inflation. The Federal Reserve Board, led by chairman Alan Greenspan, has abetted that view by steadily raising the cost of borrowing and investment over the past five months to cool the economy. Greenspan raised rates on interbank loans, which influence other costs of credit, four times from February to May. But those actions perversely left the markets expecting further increases. Clinton said at the end of April that the board had gone far enough. And a congressional joint economic committee on May 3 assailed interest-rate increases as “the greatest threat to continued growth.” But many analysts forecast another increase before this week’s Naples summit.

Against the argument that the dollar’s decline will fuel U.S. inflation—because imports from strong-currency countries will be more expensive—some analysts note that a substantial volume of U.S. trade is conducted with countries, including Canada,

where relative exchange rates have changed little in recent months. Indeed, some commentators say that the Clinton administration may be willing to ride out the currency upheaval. A low-valued dollar makes U.S. exports cheaper in such overseas markets as Japan and Germany, the argument goes, and that could fuel an export boom that would pay off economically at home in advance of the 1996 presidential election.

Other analyses argue that the currency shift is a greater problem for Japan because the higher yen makes its exports more expensive abroad. That puts further pressure on Tokyo, even under its new Socialist prime minister, Tomiichi Murayama, to comply with Washington’s demands, in protracted trade talks, to open its restricted market more widely to U.S. imports and help redress a persistent U.S. deficit in trade between the two countries. Washington has adamantly denied speculation that it encouraged the climb of the yen to exert pressure on Tokyo. But if those denials are true, the currency upheaval works to the U.S. advantage in that respect.

While the byzantine debates rage, a private group of financial experts led by Paul Volcker, Federal Reserve Board chairman from 1979 to 1987, is devising a plan to bring discipline to currency markets. The Volcker group calls itself the Bretton Woods Commission, which invokes a 44-nation agreement signed 50 years ago at Bretton Woods, N.H., to regulate exchange rates. The system, devised at a three-week conference in July, 1944, led by economist John Maynard Keynes, fixed all exchange rates relative to the U.S. dollar. Dollars, in turn, could be converted into gold by central banks at a fixed price.

But that system began to crack in the mid1960s, and gave way to market-dictated rates in the early 1970s. Canada was the first major trading nation to adopt a floating rate, on May 31, 1970—“for the time being,” said Finance Minister Edgar Benson—after a costly and inflationary attempt to hold its value near the regulated 92.5 U.S. cents. The Canadian dollar quickly rose close to parity with its U.S. counterpart. In 1976, Canada’s first year at a G-7 economic summit, the Canadian dollar traded at an average of $1.01 U.S. (Last week, it closed at 72.28 U.S. cents.)

A year after Canada floated its currency, Washington floated its dollar as part of austerity measures to fight inflation and its first trade deficit since 1893. The move came on Aug. 15, 1971. Currency markets closed for a week to absorb the shock. When they reopened, the U.S. dollar rose to an exchange rate of 341.40 yen and 3.42 marks. U.S. Treasury Secretary John Connally proposed negotiations for “a basically new international monetary system.” The world is still waiting. □

Greenback blues

Feb. 4-U.S. federal reserve raises short-term interest rates I I I I Feb. 11-U.S. President Bill Clinton and Japanese Prime Minister Morihiro Hosokawa declare trade talks between their two countries a failure