Deficit Leaves U.S. Little Choice but to Let Dollar Fall
The sharp surge in the trade gap gives U.S. economic policy-makers little choice but to let financial markets drive the value of the dollar down, analysts said Thursday.
The Reagan Administration and the Federal Reserve have lost any effective policy levers over the U.S. currency, economists said, as long as they remain reluctant to run the risk of pushing the economy into a recession by boosting interest rates to halt the dollar’s slide.
“They can smooth the decline by intervening in the (currency) market, but the trade number was so horrendous that there aren’t any credible policies that would stabilize the dollar right now,” said Robert Hormats, vice chairman of the Goldman Sachs investment firm in New York. “You just can’t play King Canute to this currency market,” he said, in a reference to the ancient king who tried to hold back the tide with a wave of his hand.
Although central banks can support the U.S. currency by buying dollars in exchange markets, the Fed’s principal tool for influencing the dollar is its control over interest rates. The Fed is able to make it more attractive for investors to hold dollar-denominated securities by pushing interest rates up, but higher borrowing costs run the risk of damaging the U.S. economy.
The irony behind the disappointing trade figures is that they appear to reflect unexpectedly strong demand for goods in the United States just before October’s stock market crash. That should help the economy survive any sharp blow from the market’s plunge without a recession in 1988 that Reagan Administration officials fear could ruin their hopes of keeping the White House in Republican hands. The Administration, responding cautiously to October’s sharp rise in the trade deficit, avoided any statements designed to bolster the dollar.
Administration policy-makers said they were surprised that financial markets did not respond even more negatively to the trade report. “It’s too early to say how we are likely to react with policy changes,” one Administration official said. “We’re waiting for the other shoe to drop, but so far this doesn’t look like a crisis.”
Most economists said that a further drop in the dollar is unavoidable as long as the nominal trade deficit shows little signs of narrowing. But a further decline in the dollar, at least initially, is likely to make the trade deficit worse rather than better.
The gap between the volume of exports and imports has narrowed considerably in the past year. Yet the monthly trade deficit figures have continued to swell because the dollar’s depreciation helps push up the price of imported goods without--so far--driving Americans to switch in large numbers to less expensive domestic products.
“I’m afraid it has to get worse before it can get better,” said Paul Krugman of the Massachusetts Institute of Technology, one of many economists who contend that a further drop in the value of the dollar is the only way under current policies to close the trade gap.
“We should be following a policy of benign neglect toward the exchange rate,” he said. “This is a bad time to be trying to resurrect the Louvre accord,” the agreement in Paris last February between leading industrial democracies to work together to stabilize currency rates.
Although the Reagan Administration continues to talk of reaching a new accord to support the dollar at lower levels than agreed upon in Paris, officials have made it clear since the stock market crash in October that they are unwilling to run any risk of a recession to help prevent the dollar’s decline.
Other analysts, however, worry that foreign central banks may find it impossible to prevent a rout of the dollar if private investors continue to abandon the U.S. currency because of their losses on earlier investments in the United States.
“The heart of the problem is that no one is convinced that the U.S. wants to stabilize the dollar,” said Stephen Axilrod, vice chairman of Nikko Securities in New York. “I’m afraid that foreign investors are close to throwing in the towel, which could force policy-makers to take some awfully drastic steps to defend the dollar.”
Analysts also point to disappointment over last month’s budget deficit agreement between congressional leaders and the Reagan Administration and to the West German economic stimulus package announced last week--now being assessed as relatively ineffective--as adding to the pressure on the dollar.
“Policy measures didn’t go far enough in either Germany or the United States but there just don’t seem to be any other serious moves available right now,” said Robert Solomon, a leading international monetary economist at the Brookings Institution here.
“In that case, additional depreciation of the dollar is probably what is needed. But this kind of unexpected shock is an unfortunate way to get it,” he said.
