Failing Dollar Hits New Record Lows : Signs Grow of Friction With Trading Partners Over How to Halt the Plunge

The dollar ended 1987 in full-scale retreat against the stronger currencies of Japan and West Germany, falling to record lows amid growing signs of friction between the United States and its major trading partners over how to stabilize the tumbling currency.

An estimated $1-billion purchase of dollars by the Bank of Japan on Thursday, backed by smaller purchases by the central banks of West Germany and Switzerland, did little to raise confidence in the greenback, which skidded to its 11th record low in 17 days in Tokyo. The plunge has moved the dollar to levels not seen since the Japanese yen was realigned after World War II and the West German mark was created in 1948.

“The market has lost patience with the U.S. trade deficit,” said David Wyss, an economist with Data Resources Inc., a consulting firm in Lexington, Mass. “It has lost patience with the U.S. Congress. It’s pushing the dollar down and will continue to do so for a while.”

Stunning Decline

The dollar’s stunning decline of recent days--against the wishes of this country’s major trading partners--suggests that investors throughout the world are losing patience with the persistent U.S. debts in trade and the federal budget and will increasingly demand higher interest rates in return for holding U.S. Treasury bonds and other dollar-denominated investments, analysts said.

The dollar closed at 121.05 yen in New York trading, down more than two yen from Wednesday’s close and lower than the 122-yen close in Tokyo. It finished at 1.5705 marks, down from 1.5945 marks on Wednesday. By comparison, the dollar concluded its 1986 trading at 158.05 yen and 1.91 marks. The dollar sank to record depths Thursday against the Swiss franc and Dutch guilder also, and it stood at a six-year nadir against the British pound, Italian lira and French franc.

The dollar’s weakness spread gloom to the stock market on the last trading day of a turbulent year. The Dow Jones average of 30 industrial stocks fell 11.27 to 1,938.83. Despite the debilitating stock crash in October, the Dow ended 1987 with a net gain of 42.88 points, or 2.26%--testimony to the furious run-up in stock prices earlier in the year.

Although the stock market seems to have stabilized lately, that has not been the case with the dollar. The dollar’s continuing plunge is causing discord between the United States and other industrial nations over the appropriate level of U.S. interest rates and also over the wisdom of the huge dollar purchases that other countries made in 1987 to keep the dollar from sinking even more precipitously.

Sought Higher U.S. Rates

European finance ministers, led by British Chancellor of the Exchequer Nigel Lawson, pushed unsuccessfully last week for higher U.S. interest rates, reflecting their growing concerns about the global financial imbalances. But, according to an article in the Washington Post, Treasury Secretary James A. Baker III turned them down for fear that higher rates would plunge the U.S. economy into a recession in 1988, an election year.

In another example of the growing tensions, West German central bank President Karl Otto Poehl warned Thursday that the continuing central bank purchases of dollars were financially disruptive and “cannot be used without limits without serious consequences for the monetary policy of creditor countries.”

During 1987, the world’s central banks bought more than $90-billion worth of dollars in an effort to prop up the U.S. currency. They were led by the Bank of Japan, which purchased in the range of $40 billion to $45 billion. West Germany’s Bundesbank was next, with about $20 billion in dollar purchases, according to the WEFA Group, economic consultants in Bala-Cynwyd, Pa.

But, when a country such as Japan or West Germany makes huge purchases of dollars, the ultimate effect can be to spark inflation. Moreover, the purchases--while enormously costly--have done little to reverse the dollar’s downhill roll. “The central banks are trying to control the slide of the dollar, but so far all they’ve lost is money and credibility,” economist Wyss said.

At the same time, U.S. policy makers have condoned much of the dollar’s fall from its peak in February, 1985, and it is not entirely clear whether the Reagan Administration wants the fall to stop. The Federal Reserve, for example, bought an estimated $10-billion to $15-billion worth of dollars in 1986, more as a way to prevent a panicky free-fall than as a serious attempt to reverse the dollar’s course.

Earlier this week, White House spokesman Marlin Fitzwater said the Administration felt strongly that any further decline in the dollar would be “counterproductive.” But Beryl W. Sprinkel, chairman of President Reagan’s Council of Economic Advisers, had previously disclosed that a recent agreement between the United States and six major industrial powers to stabilize the dollar included no new policies.

Although it may sound like a worrisome development, the weaker dollar has many implications for the economy, some of which are good.

Products More Competitive

Since falling from its zenith almost three years ago, the cheaper currency has enabled U.S. manufacturers to price their products more competitively in key European and Asian markets. This has brought new vitality to a whole array of traditional American industries, including steel, chemicals, paper products and business equipment. The newly energized manufacturing sector emerged as the strongest part of the economy in 1987 and has raised hopes that the trade deficit will shrink substantially this year.

But the plunging dollar has become a destabilizing force in the world economy because nobody knows how far it will fall. This uncertainty has made foreigners less inclined to buy U.S. Treasury bonds--purchases that are critical to financing the U.S. budget deficit. It raises fears of inflation here and abroad. And it has undermined the stature of U.S. leadership in the world.

“You can see it in Tokyo. You can see it in London,” said David M. Jones, chief economist at Aubrey Lanston & Co., a New York securities firm. “Foreign investors are just not impressed by the actions taken by the Reagan Administration so far to defend the dollar and show greater fiscal discipline.”

He added of the dollar’s decline: “Essentially, it’s a crisis in confidence in our government’s ability to manage our currency and our economic affairs.”

Still Buying Imports

Despite the signs of improved U.S. competitiveness, the monthly trade deficit reports have continued to disturb the financial markets, because Americans have been buying large quantities of imports, even at rising prices.

Some experts say the trade deficit illustrates a nation living beyond its means and that this has been reflected in the weakening currency. Data for the first 10 months of 1987 shows a trade imbalance running at an annual rate of $175 billion, according to the Commerce Department.

Convincing evidence that the trade deficit is shrinking would have a major beneficial impact on the dollar. As a result, there is unusually keen interest in the next monthly trade report--the one for November, scheduled for release on Jan. 15. “If the trade number is another really bad one, then the dollar could go into a steep slide,” said Anne Parker Mills, a currency analyst with Shearson Lehman Bros. in New York.

In something of a paradox, this week’s report that the leading economic indicators fell sharply in November could be good for the dollar. The reason is that, in a slower economy, consumers would buy fewer imports and the trade deficit would improve.

Lower Living Standard

The price, however, would be a decline in the U.S. standard of living, a politically explosive sacrifice that many economists maintain is necessary to ease the nation’s foreign debts. “It was real folly to carry this thing as far as they did--and now they’re going to have to pay to correct it,” said Jerry Jordan, chief economist at Los Angeles’ First Interstate Bancorp, of the Administration’s willingness to condone the dollar’s dive and allow a big budget deficit.

The dollar’s ultimate destination remains a mystery. The reason is that, in today’s world, where exchange rates are determined in the frenetic marketplace, experts have no agreed-on means of measuring the relative value of one currency against another. In the long run, such factors as a nation’s inflation, economic growth and productivity all contribute to the value of a currency. But short-term movements can be driven by “people sitting at a trading desk making money that day,” observed Carlos Castellanos, a vice president with Geoffrey Bell & Co., a New York financial consulting firm.

Fear of ‘Real Wipe-Out’

“We have to assume something, and we assume that it’s going to keep falling,” he said, adding: “People are really worried that, when all the traders come back (from the New Year holiday), there’s going to be a real wipe-out.”

Although there is a widespread view among traders that the dollar has yet to reach its bottom, many experts believe that it has reached a point where U.S. industrial costs are so competitive with those of other advanced nations that a natural bottom cannot be far off.