A rescue effort for the greenback

D’ARCY JENISH January 18 1988

A rescue effort for the greenback

D’ARCY JENISH January 18 1988

A rescue effort for the greenback


It was a wild week on the world currency markets. After finishing 1987 near post-Second World War lows against the Japanese yen and the German mark, the U.S. dollar started slipping again when the new year’s trading began last Monday. But central banks in Japan,

West Germany, Canada and the United States swiftly began purchasing dollars to stop the currency’s slide and provide some stability in the market. Then rumors that the United States, Germany and Japan had reached a secret agreement to support the dollar on a long-term basis drove the dollar higher. But while the greenback was recovering, the Canadian dollar rose even more sharply, posting three consecutive daily gains to reach 77.68 cents (U.S)—its highest point since April, 1984 —by Thursday, Jan. 7, before settling at 77.63 cents at week’s end. And many financial analysts said the Canadian dollar’s surge after bottoming out at 69.08 cents in February, 1986, was more than just a side effect of hectic international trading. Said Hugh Williams, senior manager in the Bank of Nova Scotia’s foreign exchange department: “The Canadian currency is strong intrinsically.”

The turbulence in the world currency markets reflected a growing anxiety among investors over the inability of the United States to deal with its two mammoth deficits, in government spending and, more significantly, in foreign trade. Indeed, the U.S. department of commerce disclosed in midDecember that the trade deficit for October —

$22.4 billion—was the largest monthly shortfall in 1987. As a result, nervous investors began dumping U.S. dollars, driving the currency to record lows, prompting last week’s central bank intervention. But there was also a consensus

that the central banks could not support the currency on a long-term basis.

Meanwhile the Canadian currency’s new surge marked an abrupt change from its performance in recent

months. For most of last year, the Canadian dollar declined in value, dropping almost as much as its American counterpart, against other leading world currencies such as the Japanese yen and the West German mark. But Williams said that toward the end of the year, the international view of Canada’s economy began to improve, with analysts seeing higher world prices for commodities such as copper, zinc and forest products as good signs for the Canadian economy. As well, in-

Charting Canada’s rebounding dollar

terest rates in Canada are higher than in the United States, which attracts foreign investors, said Williams. As a result, the value of the Canadian dollar fell much more slowly than that of

the greenback against such currencies as the mark in the final two weeks of December.

While Williams remained cautious about forecasting an even stronger Canadian dollar, some other analysts predicted that it would hit 80 cents (U.S.) during the first quarter of 1988—a level that it has not seen since February, 1984.

But the U.S. dollar could fall even further, particularly if there is no improvement in the U.S. trade deficit. The next figures, covering the month of November, are due to be released on Jan. 15, and many economists are predicting a shortfall of about $18 billion. At the same time, they foresee a total 1987 trade deficit of $224 billion, up from 1986’s record deficit of $200 billion. Said Richard Baldwin, professor of political science at Columbia University in New York: “The dollar still has to fall another 10 to 15 per cent.” o According to traditional - economic theory, the trade = deficit should have begun to

level off or even drop after the landmark Plaza Accord of September, 1985. At that time, the finance ministers of the United States, Germany, Japan, Britain and France—the so-called G5—agreed at a meeting in New York’s Plaza Hotel that they would allow their central banks to intervene in the money markets periodically. That policy was later endorsed by Canada and

Italy, which were then not full members of the international club. The objective was to bring about an orderly reduction in the value of the American dollar, which was then trading at about 240 yen and 2.9 marks. At its low point last week, the dollar traded at 120.45 yen and 1.57 marks, declines of 50 and 46 per cent respectively.

In theory, a lower dollar would make imports more expensive in the United States and less attractive to consumers. At the same time, American products would become more competitive abroad. But so far many German and Japanese companies, particularly carmakers, have undermined the effectiveness of the dollar’s devaluation by not passing along all of their increased costs to North American consumers. One U.S. economic forecasting firm, Data Resources Inc. of Lexington, Mass., estimates that Japanese auto manufacturers increased the prices of their 1988 cars by eight per cent on average in the United States.

Indeed, there is a growing belief among many economists that the tide is finally turning. Said Douglas Lee, vice-president of Washington Analysis Corp.: “The Japanese cannot squeeze

their profit margins any more.” Last week the Sony Corp. of America announced price hikes of five per cent to seven per cent, following increases ranging from five per cent to 20 per cent last fall. And the IFO Economic Institute, a forecasting firm based in Munich, is predicting that the German automobile industry will cut production by as much as four per cent this

year because of the devalued dollar after achieving record exports of 4.35 million vehicles in 1987.

After the recent turbulence in the money markets, very few observers were willing to predict where the dollar is headed in 1988. But if the U.S. trade deficit does not improve, the central banks will probably be forced to make periodic interventions in the markets to provide stability. And some analysts say that the U.S. Federal Reserve Board likely will not raise interest rates, a traditional tool for supporting a country’s currency, because higher rates could cause a recession during an election year. On the other hand, if the dollar were allowed to fall freely, the result would likely be unacceptably high inflation. At best, the central banks can try to reduce the fluctuations in exchange rates. But most experts agree that it will take a lower trade deficit, and renewed confidence in the American economy, before the dollar regains its former position as a leading world currency.