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August 5} 1977
Bou nci ng Dol lar
The dollar dropped sharply against
nearly all the other major currencies throughout most of July. But
then} just when the market was
getting the jitters} it rebounded as
smartly as it had dropped. Yet the
air is still filled with uncertainty
about the future course of dollar
exchange rates.
For quite some time} the foreignexchange market has puzzled many
observers. On a trade-weighted basis}the dollar remained remarkably
stable throughout the first half of
this year} and indeed} at midyear
was 5.5 percent higher than two
years ago. How could the value of
the dollar have moved up and
stayed up} in face of the wellpublicized deterioration in the U.S.
trade balance in the past several
years?Moreover} has an "overvalued" dollar contributed to this
trade' problem?
Trade competitiveness
During the first half of 1977}the U.S.
merchandise-trade deficit (balanceof-payments basis) reached a record high of $14.8 billion-a $30billion annual rate. This was a very
sharp deterioration compared to a
$9.2-billion deficit in 1976 and a
$9.0-billion surplus in 1975.The
same pattern has been repeated in
the current-account balance} in
which the trade figures playa
prominent role.
Does this indicate an erosion of U.S.
trade competitiveness in the world
market? Statistics have been cited
to show that the United States
spends a much smaller amount on
export promotion} relative to export volume} than do her major
trade competitors. The growing
share of foreign manufacturessuch as autos} color TVs} and
shoes-in the U.S. market appears
to suggest a weakening of the U.S.
competitive position. Because of
the fears aroused by this situation}
the Administration has been kept
busy trying to ward off demands for
increased protection against foreign imports. Meanwhile} the continued high value of the dollar in
the face of a rapidly deteriorating
trade balance has caused some observers to charge that the dollar was
overvalued and due for a sharp
depreciation. In fact} to some} the
condition appeared reminiscent of
that which prevailed prior to the
dollar devaluation in 1971.
A closer examination} however}
would show that the present condition is qualitatively different from
the pre-1971 situation. Sinc,e1970}
the U.S. wholesale-price index has .
increased 5 percent less than the
trade-weighted average index of
the other major industrial countries} whereas the U.S. dollar has
depreciated 11 percent against the
trade-weighted value of those foreign currencies. The same favorable
situation has prevailed over a longer time span. The U.S. inflation rate
since 1965 has been 4 percent less
than the average of the other major
(continued on page 2)
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Opinions expressed in this newsletter' do not
necessarily reflect the views of the management of the
Feder;.:;t\Reserve Bank of San Francisco, nor of the BOC1:rd
of Governors of the Federal Reserve System.
industrial countries, and the dollar
has depreciated about 9 percent
over that period. Thus, if by trade
competitiveness is meant price
competition, U.S. competitiveness
has improved, not deteriorated,
compared to the pre-1971 period.
The sharp deterioration in the trade
balance during the last two years
can be attributed to two fadorsone structural and one cyclical. The
structural factor refers to a twothirds rise in the volume of oil
imports, primarily attributable to a
continued U.S. subsidy to oil imports and to an effective penalty on
domestic oil production, resulting
from the existence of price controls. In value terms, the $19-billion
increase in oil imports accounted
for almost one-half of the swing in
the trade balance of the past two
years.The cyclical factor refers to
the considerably stronger economic recovery in the U.S. than in the
rest of the world. I n the past two
years,the U.S. economy has grown
at a 5.7-percent annual rate (in real
terms), compared to an average4.3percent growth rate in other industrial nations.
2
Capital flows: private and official
The explanation for the 5.5-percent
dollar appreciation since mid-1975
meanwhile must be sought in the
capital-flows data. Indeed, recorded foreign capital inflows more
than doubled from $15 billion in
1975to $33 billion in 1976,while
unrecorded capital inflows (i.e. statistical discrepancy) increased from
$5 billion to $11 billion. During the
same period, U.S.capital outflows
also increased (from $32 billion to
$43 billion), but only partially offset
the increase in capital inflows. The
same pattern appearsto have persisted through the first quarter of
1977(for which preliminary data are
now available) and also through the
second quarter (for which data are
still incomplete).
Foreign official capital inflows more
than doubled in size between 1975
and 1976,and accounted for $18
billion of last year's total recorded
inflow of $33 billion. The magnitude of these official flows raisesa
question about the working of the
managed-float exchange-rate system. There have been recurrent
chargesof foreign central-bank interventions in tHe exchange market
to keep their currencies from appreciating during a period of high
unemployment. Measuring this factoris difficult, becausecentral
banks as a rule do not publish data
on their exchange-market interventions, but some rough estimatescan
be made on the basisof published
data on official reserves.
In 1976,foreign-exchange reserves
of foreign central banks increased
by more than $25 billion, compared
to a $5-billion increase in 1975.A
similar heavy buildup of reserves
has continued into 1977.Of the
1976increase,OPECcountries accounted for only $7.4 billion, while
$8.5billion wound up in the hands
of Japan,Germany, and Switzerland. The OPECreserve increases
could be regarded as similar to
private capital flows. The increases
recorded by the major industrial
countries, on the other hand, reflected attempts to slow down the
rate of appreciation of their respective currencies.
Recentdevelopments
At this point, only conjectures can
be made regarding the factors underlying the abrupt drop in the
3
dollar's exchange value during July.
Trade-balance deterioration is not
likely to have been a direct facto.,
since it had been going on for two
years, with no apparent effect on
the exchange rate. There is also no
indication of an abrupt withdrawal
of foreign central banks from the
exchange market. One must therefore look for a
to a sharp
decline in foreign private capital
inflows, including OPECfundsreflecting perhaps increased uncertainty over the short-run prospects
of the dollar. This could have occurred as a result of official U.S.
insistence on the need for appreciation of the strong currencies as
an aid to the international adjustment process.
Over the longer run, the value of
the dollar will depend not only on
the prospects for the U.S. trade
balance, but also on the dollar's
continued usefulnessas an internationalliquid assetfor both foreign
official and private holders. For
both types of holders, there does
not appear to be any real alternative to the dollar on the horizon.
Hang-Sheng'Cheng and
Nicholas Sargen
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BANKING DATA-TWELFTH FEDERALRESERVE
DISTRICT
(Dollar amounts in millions)
Selected Assetsand liabilities
large CommerdalBanks
Amount
Outstanding
7/20/77
7/13/77
-
Loans (gross, adjusted) and investments*
Loans (gross, adjusted)-total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.s. Treasury securities
Other securities
Deposits (less cash items)-total*
Demand deposits (adjusted)
U.S. Government deposits
Time deposits-total*
Statesand political subdivisions
Savingsdeposits
Other time depositst
Large negotiable CD's
98,473
75,771
1,834
23,573
24,492
13,140
8,782
13,920
97,137
27,716
469
67,042
5,645
31,947
27,547
10,074
Weekly Averages
of Daily figures
Week ended
Member Bank Reserve Position
ExcessReserves(+)/Deficiency (-)
Borrowings
Net free(+)/Net borrowed H
federal funds-Seven Large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales (-)
Transactions with U.S. security dealers
Net loans (+)/Net borrowings (-)
Change from
year ago
Dollar
Percent
Change
from
-
+
+
-
+
+
+
-
390
63
276
50
113
76
65
262
916
972
125
123
17
34
71
227
+
+
+"
+
+
+
+
+
+
-
+
-
+
+
-
Week ended
7120/77
7/13/77
+
+
+
+
+
+
+
+
9,644
8,908
456
1,817
4,097
1,838
850
1,586
7,372
2,686
102
4,591
411
5,431
256
1,996
-
+
+
+
-
+
-
+
+
-
10.86
13.32
33.09
8.35
20.09
16.26
8.82
12.86
8.21
10.73
17.86
7.35
6.79
20.48
0.94
16.54
Comparable
year-ago period
19
1
20
74
6
68
+
23
3
20
+ 1,364
+
897
+
92
+
+
345
+
259
+
244
*Includes items not shown separately. tlndividuals, partnerships and corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author, , , ,
Information on this and other publications can be obtained by calling or writing the Public
Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 544-2184.
@FedFRASER