Weaker Dollar Offers No Quick Fix

A. Gary Shilling is a New York-based economic consultant and author of "Is Inflation Ending? Are You Ready?" published by McGraw-Hill

On the last weekend of September, finance ministers from the Group of Five countries--the United States, Japan, Germany, Britain and France--met in Washington to mark the first anniversary of the agreement that brought down the value of the dollar. It may have been a great reunion, but it was fruitless.

A year ago, it was widely believed that the problem of the ballooning U.S. trade deficit could be solved primarily by orchestrating an orderly decline of the dollar. Back then, few agreed with me that even substantial weakness in the dollar would fail to improve the American trade balance.

In a March 4 Board of Economists piece, I noted that since the United States was practically the only source of demand growth in this recovery, foreign manufacturers would cut their profit margins rather than raise their dollar prices. If need be, they would even dump products on U.S. markets, as Japanese bearings manufacturers have recently been accused of doing. As a result, I argued, the lower dollar would not reduce U.S. imports or aid American exports significantly.

Indeed, the U.S. merchandise trade deficit this year is running well ahead of last year's record $148 billion, and protectionist pressures in Congress are mounting. Protectionism is fast becoming the most serious threat to the world economy. If it intensifies, it almost certainly will trigger retaliation against U.S. products abroad and worsen world financial problems, including that of the Third World debt, which has been exacerbated by the oil price collapse.

The finance ministers' agenda for this year's meeting in Washington was clear: come up with ways to improve the U.S. trade balance and to alleviate the deficiency in global demand.

Lack of Acknowledged Leader

Ah, but there's the rub. For the meeting's participants to agree on a common course of action, there probably needed to be an acknowledged leader in the world--such as the United States used to be in the period after World War II.

The present free-trade economic system has been developed under the aegis of the United States. After Vietnam, however, the United States lost its ability to provide leadership, and no other power arose to take its place and to check the worldwide drift toward protectionism.

Today's leaderless environment bears striking similarities to the interwar period of the 1920s and the 1930s, when Great Britain's economic domination had come to an end and the United States, though capable of assuming the reins of power, turned isolationist following World War I. At the time, "beggar thy neighbor" economic policies pursued by most nations ultimately led to the breakdown of the world economic system and contributed to the Great Depression.

Thus, failure of the Washington meeting to yield tangible results came as no great surprise, especially with the pre-meeting bickerings between U.S. Treasury Secretary James A. Baker III and Fed Chairman Paul A. Volcker on one side and German and Japanese finance ministers and central bankers on the other.

In the view of the United States, the way out of the current world trade impasse is, aside from an even weaker dollar, domestic fiscal and monetary stimulus by countries that have huge external surpluses, namely Germany and Japan. The hope is that this would lead to higher growth rates in those countries, dampening their exporting zeal and simultaneously allowing them to absorb more imports from the United States.

This view is not shared by U.S. trading partners. Germany resists adopting any stimulative measures. It is content with its domestic economic rebound in the second quarter, even though it followed two quarters of declining business activity, and it is fearful that any extra stimulus would only ignite inflation. As for Japan, despite grim prospects for its export-oriented economy in the world of the extra-strong yen, it is unwilling to go any further than a $23-billion supplementary public spending package, which most of its own economists dismiss as too little too late.

Unreceptive to Foreign Products

But even if substantially faster growth in Germany and Japan is achieved, the U.S. trade deficit problem may still not be resolved. On the one hand, the hope that those countries will absorb more U.S. exports may be unfounded.

Japan is traditionally unreceptive to foreign products, aside from raw materials and oil, and Prime Minister Yasuhiro Nakasone's efforts to persuade his countrymen to consume more imports--in part, inspired by the desire to diffuse the rising Japan-bashing mood in Europe and the United States--have not met with much success. Japan theoretically could be a promising market for U.S. farm products since its own agriculture is so inefficient. Yet, letting more foreign agricultural products into the country would present a political problem: Nakasone's Liberal Democratic Party owes a large measure of its political success to support from the nation's farmers.

Germany may not be as import-averse as Japan, but its economy is only one-fifth the size of ours and considerably smaller than that of Japan. If it is to have a noticeable impact on U.S. exports or the world economy, it needs to grow considerably faster. For instance, the U.S. economy grew at an almost 7% annual rate in real terms in the first year and a half of the current recovery, but in the latest eight quarters, since mid-1984, its growth rate has slowed to 2.5% per year.

To make up for this shortfall, in terms of global growth, the real annual growth rate of the German economy would have to be 22.5 percentage points higher--certainly an unrealistic feat!

True, as a pivotal economy in the European Communities, Germany strongly influences the world's largest economic bloc; yet the European Communities, especially with the accession of Greece, Spain and Portugal, has become a fairly ragtag crew, and it may not be able or willing to move en masse even if Germany did provide determined direction.

As far as reducing U.S. imports is concerned, faster growth in Germany and Japan holds out an equally slim hope. In the last two quarters, in response to their currencies' appreciation, both German and Japanese exports have been declining: The volume of Japanese exports, for instance, fell for the sixth straight month in August, and even auto exports registered the second monthly decline in a row.

The United States, however, has not benefited from this since its trade gap has continued to widen. While the full numbers are not yet available, it appears that German and Japanese products have simply been replaced in the United States by imports from elsewhere--Canada, Brazil and the newly industrialized countries in East Asia, whose currencies have remained unchanged against the dollar.

Moreover, such countries as Korea, Taiwan and Hong Kong have a tremendous cost advantage over their U.S. competitors: Their manufacturing workers' hourly wages are in many cases only one-tenth of what U.S. workers are paid. As they keep expanding production capabilities and venturing into increasingly more sophisticated product areas, the flood of their exports to the United States probably will continue to swell--unless it runs head-on into protectionist measures.

Will the major countries set aside their differences and cooperate in time to head off severe global protectionism? Let's hope so, but the example of the late 1920s and the 1930s is not encouraging.

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