Too Strong for Its Own Good

By Alexander L. Taylor III

The surprisingly robust dollar is a source of pride and problems

When University of Chicago Professor George Stigler travels to Stockholm next month to accept the Nobel Prize, he will experience firsthand a bittersweet phenomenon of the U.S economy. Stigler's Nobel Prize carries a cash award of 1.15 million Swedish kroner, which until only a few weeks ago was the equivalent of $182,000. Since then the Swedish government, pressed by the rising value of the U.S. dollar as well as its own economic problems, has devalued the krona. When Stigler finally receives his award, he will actually get only about $155,000.

The dollar has been on an upward vector against nearly all the world's major currencies for a full two years, confounding predictions of bankers, businessmen and economists alike. They fully expected the greenback to begin weakening this year as interest rates fell, because much of its strength derives from the massive inflow of foreign capital attracted by the high returns on U.S. investments. Instead, the dollar has kept getting stronger, largely because inflation has been declining so rapidly in the U.S. and returns are still high compared with those in other countries, where interest rates have also dropped.

Another reason for the inflow is that the U.S. is seen as a safe haven for foreigners' capital. International tensions have been heightened by currency controls, instability in Latin America and troubled economies in Europe. As Joly Dixon, Counselor of Economic Affairs for the European Community, asks bluntly, "Where else are you going to put your money?"

The U.S. consumer has prospered widely from these developments; the same size budget can now buy more Italian wines or French food processors. Life is also sweeter for American tourists traveling abroad (see box). Importers and corporations that buy raw materials from overseas have seen their costs cut dramatically. But the strong dollar has been a disaster for American exporters of everything from textiles to computer terminals, because it translates to foreign buyers exactly like a hefty price hike.

With importers having a field day in the U.S. and American exporters stymied abroad, the merchandise trade gap has widened. Last week the Commerce Department announced that the September deficit amounted to just over $4 billion. While this is an improvement over August's record shortfall of $7.1 billion, the overall trend has led to expectations of a merchandise trade deficit of $43 billion this year, the worst ever, and an even larger one in 1983.

The merchandise gap is now more than offset by U.S. surpluses in other international transactions. The U.S. sells more services abroad (such as those of engineering and construction firms) than it buys. Moreover, despite the large inflows of foreign capital, the U.S. still earns more from its foreign investments (in dividends and interest, for example) than it pays out. But some economists expect the merchandise deficit to rise so much that it will offset the surpluses elsewhere in the U.S. balance of payments.

Since the beginning of this year, the dollar has increased 14% against the West German mark and British pound, and 26% against the Japanese yen and the French franc. Economist Robert Feldman of the Federal Reserve Bank of New York calculates that the dollar has risen 20% against the currencies of America's major trading partners over the past two years. This has more than made up for the dollar's losses in 1977 and 1978, when there was grave concern over its weakness.

One reason foreign currencies are weaker is that inflation has not fallen as quickly abroad as it has in the U.S. Last week the Commerce Department reported that consumer prices rose at an annual rate of only 4.8% in the first nine months of this year, less than half last year's 10.1% pace. Part of the credit goes to the falling prices of imports, which not only have a direct influence on the consumer price index but also put downward pressure on domestic prices of similar goods. In this way, the strong dollar and falling inflation tend to reinforce one another.

The dollar has also been pushed up by the sogginess of foreign economies. As the recession has deepened in Western Europe this year, the French franc, Belgian franc, Swedish krona and Italian lira have all been officially devalued. Swiss authorities have taken deliberate steps to reduce the worth of the once mighty Swiss franc.

In Japan, where sluggish consumer spending has slowed economic growth, the dollar has gained so much ground that Rimmer de Vries, the chief international economist of Morgan Guaranty Trust Co., says: "The problem is not so much the strength of the dollar as the weakness of the yen." Last week the yen sank to a five-year low of 278.5 to the dollar. Since the end of 1978, the yen has fallen 30% in value against U.S. currency. Economists note that such a drop can wipe out productivity gains in the U.S. like those in the auto industry. What good does it do to cut production costs by 5% if the dollar appreciates by 10% against the currencies of countries like Japan that are exporting cars into the U.S.?

Some Americans have become convinced in the past year or so that Japan is purposely keeping the yen cheap by such means as setting up barriers to prevent the inflow of capital investment. Whether this is true or not, these critics are getting an audience. Last week Charles H. Percy, chairman of the Senate Foreign Relations Committee, asked for an inquiry into whether the Japanese government has intentionally depressed the yen.

While coping with greater resistance from foreign customers, U.S. multinational corporations are also taking a financial beating. The profits of their foreign subsidiaries, which are accumulated in foreign currencies, are worth less when they are converted into U.S. dollars for reports to shareholders. Airlines have been especially hard hit. A spokesman for embattled Pan American World Airways estimates that the strong dollar has cost his company $100 million. That could mean the difference between survival and bankruptcy for Pan Am.

Many Europeans now fear that the U.S. will impose trade barriers, such as those that already exist for automobiles and steel, on other products to protect American businesses. Pressure for protectionist measures has been mushrooming. A Florida manufacturer of machine tools has asked the White House to block investment tax credits on Japanese-made machinery. Chemical companies will be actively seeking additional shelter from foreign imports in the next session of Congress. Even uranium producers are invoking national security as an excuse to ban the purchase of uranium overseas.

Trying to halt the spread of new import quotas and restrictions is one of the goals of a meeting in Geneva later this month among the representatives of the General Agreement on Tariffs and Trade, known as GATT. It is unlikely, however, that any such agreement can be reached. The European nations themselves are worried about the flood of inexpensive imports from Third World nations like South Korea and Taiwan. The Reagan Administration has generally taken a position in favor of free trade, but with unemployment at 10.1%, it will be hard-pressed to maintain its stance.

No one denies that the strong dollar is stunting growth in the U.S. Nearly one-sixth of the economy depends on exports. It is estimated that each $10 billion in the trade deficit increases the jobless rate by .7%, or more than 500,000 people. C. Fred Bergsten, director of Washington's Institute for International Economics, believes that "the trade deficit is the biggest single factor pushing the economy down." Building new trade barriers, however, would only sap the economy further by propping up sickly industries, raising prices for consumers and inviting reprisals from other countries.

In coming months, the problems of the trade deficit are likely to become even more acute. European nations like France may have to devalue their currencies further or simply allow them to weaken so that these nations can help their sick economies while protecting their domestic markets from cheap imports. In Spain, for instance, the peseta fell to a historic low against the dollar last week, and the new Socialist government is expected to let it continue falling. The U.S. will suffer even more if its economy gets out of sync with the rest of the world. Should business and consumer spending pick up quickly in the U.S., imports would accelerate while foreign customers remained too strapped to buy more U.S.-made goods.

Like a weight lifter who spends too much time in the gym, the U.S. dollar has become musclebound. It will take a further decline in interest rates and an international economic recovery before American currency can begin to be brought into balance with the rest of the world.

--By Alexander L. Taylor III. Reported by Lawrence Malkin/Paris and Frederick Ungeheuer/New York

With reporting by Lawrence Malkin, Frederick Ungeheuer

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