Currency intervention: economic jury on the US dollar is still out'
One week ago the United States, Britain, France, West Germany, and Japan began a concerted campaign to lower the value of the dollar. A week into the process, it appears to have worked. But will it really have the desired effect? The history of currency interventions is mixed. If countries intervene to push a currency a certain way when it's already headed that way, the intervention can appear to succeed because it has market forces going with it. Or an intervention at a time of widespread speculation in a currency can keep speculators out of the market for a while.
This intervention came at a time when the dollar had already been declining gradually, but there did not seem to be rampant speculation. So far it doesn't appear that very large amounts of foreign exchange have been used to lower the dollar. The amounts that foreign banks can use to push exchange rates around, however, seems to be quite limited in relation to the amount of foreign exchange that now sloshes around in exchange markets every 24 hours. Thus, one has to question whether the operation b egun last week has the staying power it would require to be a long-term success.
There is a more important issue to consider, however. It appears that this plan to lower the value of the dollar was put together largely to counter growing pressure from Congress for some form of import controls. Congress, unwilling to take the steps necessary to lower the federal deficit -- and knowing that President Reagan would veto a tax increase -- is trying instead to play with one of the most serious side effects of that deficit: poor US export performance.
The agreement reached on Sept. 22 seems to ignore the unpleasant side effects of a sudden lowering in the value of the dollar. The US has become dependent on foreign willingness to finance its budget deficits. A substantial part of its $200 billion deficit is being financed by foreign purchases of US government bonds. If the dollar suddenly declines, what about foreign holdings of US bonds or purchases of new bonds?
One scenario is that the Federal Reserve would have little choice but to raise interest rates again to attract foreign funds to our markets. This, other things being equal, would have the effect of stemming the decline in the dollar's value. Another scenario is that the Fed would have to be excessively loose with the money supply to avoid crowding out normal commercial and consumer financing needs at home. That, of course, would ignite new fears over an eventual return of high inflation.
Fed chairman Paul Volcker has said that a lower dollar would not improve the trade deficit until the nation deals with its fiscal problems. The accord reached last week seems to have been the work of the Treasury Department, which has become more interventionist under Secretary James A. Baker III. It could not be effective, however, without action by the Fed to carry it out. No one knows whether the Fed is a reluctant convert to this interventionism.
Last week's initiative can really have little permanent effect until the fundamental imbalance in the US economy is dealt with. That imbalance is the $200 billion budget deficit, which both the President and Congress talk about, but whose seriousness they have failed to comprehend.
And last week's efforts, while they may yet mobilize billions of dollars of central-bank reserves to change the course of currency exchange rates, are likely to be only a Band-Aid in terms of changing the course of trade flows. Just as in the early 1970s, when the dollar suffered its humiliating devaluation, foreign exporters will settle for lower or even no profits in the short run to keep their exports flowing to the US and their domestic labor forces at work.