Around-the-clock battle raged on the world’s currency markets last week as the central banks of the Group of Seven (G7) major Western industrialized nations flexed their financial muscles and sold billions of U.S. dollars in an effort to drive down the greenback’s value. They were acting on the instructions of their finance ministers, including Canada’s Michael Wilson, who emerged from an annual meeting of the International Monetary Fund in Washington, D.C., and issued a terse statement warning that the continued ascent of the U.S. dollar “could adversely affect prospects for the world economy.”
Wilson and his colleagues said that they are concerned by the fact that, after falling in value for more than three years against the Japanese yen and the West German mark, the dollar has climbed too fast this year. In the process, American products have become more expensive abroad, while Japan and West Germany’s chronic trade surpluses have made their products cheaper in the United States. If those trading patterns continue, the Western leaders say that they fear the United States might become protectionist and close its enormous market.
The initial response to the show of force by the central banks was swift: the dollar fell sharply on Monday against the yen and the mark and continued to decline over the rest of the week. Meanwhile, the Canadian dollar, which traders say does not— historically—fluctuate wildly, held steady at around 85 cents (U.S.).
But many economists say that they expect investors will continue to pour money into the still-expanding American economy, despite the efforts of the G7 and despite Washington’s inability to come to grips with its massive federal budgetary and international trade deficits. They added that as long as investors remain optimistic about the prospects for sustained U.S. growth—and as long as nations such as Germany and Japan refuse to raise their own interest rates to reverse the flood of money into the United States—the upward pressure on the greenback will continue. Declared Michael Hart, a vice-president of Toronto-based currency dealer Friedberg Commodity Management Inc.: “It’s like spitting in front of a supertanker.”
So far this year, overwhelming confidence in the U.S. economy has resulted in the dollar’s soaring by about 20 per cent against the yen
and by about 25 per cent against the mark. The surge followed a steady decline that began after the so-called G5 partners—the United States, Japan, West Germany, Britain and France—signed the Plaza Accord in New York City in 1985.
Under that agreement, which Canada and
Italy endorsed the following year as members of the new and expanded G7 meeting in Tokyo, the governments agreed to have their central banks sell U.S. dollars and buy weaker currencies. Their aim: to make the weaker currencies more scarce on world markets, raising their value relative to the plentiful greenbacks.
And last week, the world’s leading central banks, including the Bank of Canada, decided the dollar was climbing too quickly and intensified their efforts to sell U.S. dollars and buy yen and marks. Merfyn Jones, chief foreign-exchange dealer for the Canadian Imperial Bank of Commerce (CIBC) in Toronto, estimated that the central banks spent as much as $2.4 billion a day in order to force the greenback down. But
even that huge intervention was only a small part of the volume of currency traded worldwide, which in London alone amounts to $220 billion worth of currency daily.
According to conventional economic theory, the U.S. trade deficit—the gap between what the country earns from exports and the much larger amount that it spends on imports— should push the dollar down as U.S. buyers trade their greenbacks for foreign currencies to pay for those imports. The chronic deficit, in turn, should add to the supply of dollars on the world market, making the dollar cheaper relative to other currencies.
But investors are still being lured to invest in U.S. dollars because of high interest rates. They are also apparently encouraged by the fact that the country is now in the midst of its seventh straight year of economic expansion. That phenomenal growth has continued despite massive borrowing by Washington to fund its domestic budget deficit of $190 billion for 1989.
But the ClBC’s Jones says that Washington’s borrowing does restrict the ability of U.S. Federal Reserve Board chairman Alan Greenspan to reduce interest rates. At the same time, the West German and Japanese governments are both reluctant to raise their rates because both face elections within the coming year and they do not want to risk slowing the growth of their own economies. Without significant changes in international interest rates, Jones said, last week’s dollar sell-off will probably not depress its value for long.
For his part, Bank of Canada governor John Crow claims that the Canadian situation is different because interest rates are already higher than those in the United States. And while the yen and the mark have faltered this year, the Canadian dollar has continued to rise with the greenback. As a result, Canada’s balance of trade deteriorated to a $4.4-billion deficit in the second quarter from a $2.2-billion surplus of exports over imports in the first quarter. Douglas Peters, chief economist with the Toronto-Domin-
ion Bank, said that that decline should
lead Wilson and Crow to reduce interest rates and allow the value of the Canadian dollar to decline, making Canada’s exports cheaper.
But Peters and other private economists acknowledge that Crow and Wilson are still determined to fight inflation. Like the central bankers in other G7 countries, Crow appears to be unwilling to use his most effective tool for altering the value of his own and other currencies. But as the debate over the greenback’s value continues, Crow may yet be forced to use that powerful weapon.
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