Falling Back to Earth

By John Greenwald.

During the first half of the 1980s, the value of the U.S. dollar seemed to be going into orbit. While American consumers enjoyed cheap imports and luxuriated in foreign travel bargains, U.S. manufacturers complained bitterly that they were being clobbered by overseas competitors. But early last year the dollar bailed out, with a slight push from anxious international moneymen. At first the decline was a gentle drift, but it is now showing signs of becoming a free fall. Since December the dollar has dropped by 19% against the Japanese yen and 8% against the West German mark. It dipped last week below 180 yen for the first time since October 1978, when the American currency seemed so feeble that President Carter announced a dramatic rescue plan. Economists now wonder whether the current decline will end in a soft landing or a painful crash. Says Alan Greenspan, a New York City economic consultant: "There is an increasing danger now that the dollar's fall may prove to be as big a problem to the U.S. as its climb."

Much of the dollar's dive can be traced to a meeting held last September at Manhattan's Plaza Hotel by finance ministers and central bankers from the Group of Five, consisting of Britain, West Germany, France, Japan and the U.S. Deciding that the dollar was overpriced, the officials agreed that their countries would sell dollars on foreign-exchange markets in a coordinated effort to bring down their value. The plan worked, but it may have proved too successful.

Washington's top moneymen seemed to disagree last week about the best course for the dollar. Treasury Secretary James Baker told Congress that the Reagan Administration "would not be displeased" with further declines, provided that they were "orderly." But Federal Reserve Chairman Paul Volcker testified that the currency has already "fallen enough." Added Volcker: "I don't want to see a loss of confidence in the dollar."

Experts agree that a falling currency, like a rising one, offers both opportunities and perils. By making American companies more competitive with foreign rivals, it should help shrink the U.S. trade deficit, which hit a record $148.5 billion last year. Narrowing that gap would create jobs and boost the gross national product. Government figures released last week showed that the GNP grew at an annual rate of only 1.2% in the fourth quarter of 1985 and 2.3% during the year as a whole, the smallest increase since 1982. The weakening dollar will also reduce demands that Congress take protectionist action against imports.

The decline, though, has brought higher costs for foreign goods and overseas vacations. Sony recently raised prices by 5% on its entire line of color television sets because of the falling dollar. A 19-in., remote-control model, for example, now costs $630, vs. $600 in December. Prices of Japanese cars and machine tools have also risen by 5% since December. Last week the American subsidiary of West Germany's Mercedes-Benz added 5.8% to the sticker price of its autos. Pouilly-Fuisse, a popular white burgundy that sold in stores for about $12 in 1985, now goes for as much as $15 for a bottle of the same age and quality.

Such increases, together with hikes of up to 12% on cameras, stereos, videocassette recorders and other imports, have raised fears of renewed inflation. As a rule of thumb, each 10% drop in the dollar's foreign-exchange value adds 1.5 percentage points to the U.S. price level. The risk becomes greater the further the dollar falls. Said Volcker: "Sharp depreciation in the external value of a currency carries pervasive inflationary threats."

For now, however, prices are being held in check by the continuing drop in the price of oil. Last week the top grade of Texas crude fell below $14 per bbl. for the first time since 1979. Six months ago the same Texas grade sold for about $27. In London last week British North Sea oil dipped to $17 per < bbl. as Saudi Arabia, which owns the world's largest petroleum reserves, continued to pump an ocean of crude to raise its share of the market.

U.S. inflation may also be restrained by the strategies of foreign manufacturers. Many firms that export to the U.S. made fat profits when the dollar was enormously strong, and now some are choosing to wait before substantially jacking up prices. West Germany's Porsche last week reported a 30% jump in 1985 profits. With those earnings as a cushion, the Stuttgart- based company, which exports half its autos to the U.S., plans to maintain its share of the luxury sports-car market by holding this year's sticker increase to 4%.

Plunging oil prices have been an important cause of the dollar's decline. Says Christine Patton, chief currency trader for New York City's Manufacturers Hanover Trust: "The oil price is driving the foreign-exchange market." She reasons that many foreign countries have benefited more than the U.S. from falling prices for petroleum, which is traded in dollars, because their strengthening currencies make oil cheaper for them than for American buyers. That good fortune bolsters their economies and makes their yen and marks stronger.

The European economic outlook is growing rosier every day. Says Jacques Bourgeois, director at the French Bureau d'Informations et de Previsions Economiques, a leading forecast center: "The conjunction of the falling dollar and falling oil prices is a marvelous gift for France." The twin slides are cutting so much from France's bill for imported oil that the country expects to turn a projected $1.3 billion trade deficit for 1986 into a $5 billion surplus. In Bonn, West German leaders expect the drops in the dollar and the cost of oil to propel the economy to a 4% growth rate in 1986, compared with 2.5% last year.

The falling dollar is a source of joy to American manufacturers, many of which have been priced out of foreign markets. General Electric lost a $350 million contract for a power plant in Saudi Arabia in January 1985, when the sky-high greenback helped Japan's Mitsubishi become the low bidder. By last November, though, a 20% drop in the dollar enabled G.E. to win a similar contract in Pakistan. Said Chairman John Welch: "We've got a real chance that America can compete again. American competitiveness looks so much better than it did just six months ago."

The cheaper currency is particularly welcome in the industrial Midwest, / where some companies have never fully recovered from the past recession. "The reaction here is very positive," says Stephen Newhouse, a spokesman for Caterpillar Tractor (1985 sales: $6.7 billion), which does some 50% of its business overseas. "A cheaper dollar certainly gives us immediate help in countries where we compete with Komatsu of Japan." American carmakers also are delighted because the declining dollar removes some of the $2,000-per-car cost advantage that Japanese auto firms have held in the U.S. Partly as a result, Chrysler Chairman Lee Iacocca announced two weeks ago that his company will begin selling cut-rate versions of its Dodge Omni and Plymouth Horizon subcompacts next May for as little as $5,499, less than comparable Japanese autos.

Makers of high-technology goods are jubilant too. Last year U.S. imports of electronic equipment exceeded exports by $8.6 billion, and the falling dollar should help reduce that imbalance. Says Ralph Thomson, senior vice president of the American Electronics Association, which represents 2,700 manufacturers of everything from microchips to medical instruments: "Among the major barriers that we face in international trade, the strong dollar has been the primary one. When we see that situation changing, we say 'Bravo!' "

While a falling dollar may limit the bargains available to U.S. travelers who venture overseas, it should boost the domestic tourist industry. In Florida, which boasts attractions ranging from Disney World to Miami Beach, hoteliers and resort owners expect a hectic year. Arnold Keithlin, marketing vice president of the Sonesta Beach Hotel on Key Biscayne, met last month with European travel arrangers and came away beaming: "They were forecasting a 35%-to-45% increase in their use of tourist facilities here this summer because of the depreciation of the dollar. They are all very bullish, very optimistic."

It could be months before the fall in the dollar that has already occurred makes a major difference in the U.S. trade deficit. Some manufacturers may find it hard to recapture the overseas business they have lost, and many foreign companies may hold on to their American customers. "We've got a foothold in the U.S. market now, and it won't be so easy to displace us as the Americans think," notes a top adviser to West German Chancellor Helmut Kohl. "German products still appeal at these prices." M.I.T. Economist Paul Krugman believes it will take at least a year for the drop in the dollar to % have "a significant impact" on the trade balance. That view is shared by Rimmer de Vries, chief international economist for Morgan Guaranty Trust, who expects only a modest decline in the trade gap this year.

Nonetheless, some U.S. trading partners are afraid that the dollar has fallen too far, too fast. Japanese firms are considering a second round of price increases because of the rising yen, which has gained 25% against the dollar in the past six months. Says Bunroku Yoshino, president of Tokyo's Institute for International Economic Studies: "Fundamentally, Japan can stand a pretty sharp strengthening of the yen. But the suddenness of the rise is difficult to adjust to. If we have more time to adjust, then it might be all right."

The Reagan Administration, however, has little inclination to check the dollar's fall. "There are no second thoughts over here," said one senior official. Still, the Treasury will soon begin a study that Reagan called for in his State of the Union address, when he directed Secretary Baker to "determine if the nations of the world should convene to discuss the role and relationship of our currencies." Such a global conference could develop ways of managing the dollar to prevent future sharp gyrations. Under one frequent proposal, which the White House has so far rejected, countries would keep their exchange rates within "target zones" designed to preserve stability.

That idea might seem desirable if the dollar continues its steep descent. Says Walter Heller, a University of Minnesota economist who served as chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson: "We definitely want the dollar to fall, but we don't want it to fall out of bed. Too much of a good thing can be a problem." Americans discovered that when the dollar rose too much, and they could find it out again as the currency heads down.

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With reporting by Christopher Redman/Washington and Frederick Ungeheuer/New York