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MAY l

O 1985

A Yen For the Dollar
Throughout the summer of 1978,
the once almighty dollar faltered.
There were periods when it lost
value by the hour.
"Stagflation" (high U.S. inflation
coupled with economic stagnation)
helped trigger a worldwide retreat
from the dollar. Investors worried
that the steadily rising U.S. inflation rate was eroding the value of
dollar-denominated investments,
while currency traders feared there
were simply too many dollars
abroad. Added to this was the
widely held perception that American businesses and industries
were consistently losing ground to
foreign competitors. All these factors combined to undermine confidence in the dollar.
To anyone who remembered the
years when Marshall Plan money
helped to rebuild Europe, the
world of August 1978 seemed
turned upside down. European
hotels and restaurants no longer
welcomed American dollars, and
unfavorable exchange rates forced
scores of dispirited Americans to
cut overseas vacations short.
For the first time in living memory, vacationers from Europe,
Asia, and Latin America flocked to
New York, Miami Beach, and
points west; and foreign bargain
hunters swarmed to the United
States on shopping sprees. German chancellor Helmut Schmidt
led European leaders in a chorus of
concern over the dollar's steep
plunge, and OPEC millionaires
rushed to exchange weak dollars
for strong German marks.
The August 27, 1978 issue of the
British weekly news magazine, The
Economist, carried a disconcerting
cover photo that reflected how far
international confidence in the dollar had fallen; dozens of dollar bills
lay crumpled against a background

U.S. interest rates rose sharply.
(Slower money supply growth exerts upward pressure on interest
rates.) As interest rates soared, the
American economy slid into recession, and inflation slowed
markedly.
Higher rates and lower inflation
also prompted investors from
around the globe to exchange
marks, francs, pounds, and yen for
dollars in order to take advantage
of high-yielding U.S. financial
assets. The increased demand for
dollar-denominated investments
pushed the dollar ever higher
against other major currencies.
Strong, Stronger, Strongest

Courtesy of Massport
A Japanese car that would cost $7,000 when
the dollar trades for 230 yen, could drop in
price to $6,700 if the dollar climbs to 240 yen.

of candy wrappers, cigarette butts,
and empty beer cans . "Dollar in the
Dirt," declared the cover story.
Changing Times

A lot can change in five years. By
the summer of 1983, the journalistic focus had shifted from "Dollar
in the Dirt" to "Why the Dollar Will
Drop" (Fortune, September 5,
1983). American tourists once
again enjoyed affordable meals on
the Continent, and European leaders voiced concern over the dollar's
strength.
The dollar had begun to regain
ground after the United States resolved to fight double-digit inflation with a more restrictive monetary policy. In late 1979, the Federal
Reserve moved to curb the growth
of America's money supply, and

From an American perspective,
the strong dollar of 1983 would certainly seem preferable to the shaky
dollar of 1978, but the dollar's resurgence has created a variety of
complex economic and political
problems. American manufacturers, for example, now find themselves at a competitive disadvantage because a strong dollar lowers
the price of foreign-made goods
relative to the price of goods produced in the United States. A
Japanese car that would cost $7,000
when the dollar trades for 230 yen,
could drop in price to $6,700 if the
dollar climbs to 240 yen. American
companies that produce textiles,
shoes, steel, electronic equipment,
and machine tools are experiencing
similar pressures, and the clamor
for protective tariffs is mounting.
A strong dollar even affects U.S.
businesses that don' t face stiff foreign competition. Take the case of a
Massachusetts firm that received
an order from France for antique
colonial furniture kits. When the
dollar rose to a record high against
the franc, the French importers reContinued on Page 2

Federal Reserve Bank of Boston Vol. 9, No. 3 - October 1983


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luctantly halved their original
order because they could not afford
as many kits after converting their
francs to dollars at the new rate.
Indeed, a strong, perhaps even
overvalued, dollar has a profound
impact on the world economy because world oil prices are set in dollars. When the dollar rises, most
countries pay more for imported oil
because they must exchange more
of their own currencies for dollars.

Unfriendly Exchange
Whereas the late 1970s saw oilproducing countries shift their surplus cash from shaky, inflationplagued dollars to stronger German marks, the 1980s have seen
that trend reverse. When U.S. interest rates continued to rise in
1980 and 1981, OPEC countries began switching back to dollardenominated investments in order
to take advantage of higher yields.
By mid-1983, the dollar was once
again, for all intents and purposes,
the world's sole reserve currency.
Some analysts attribute the influx of foreign capital and the dollar's resurgence to the relative stability of America's political and
economic institutions. Proponents
of this "safe haven" theory point to
France's nationalization of several
key industries following the 1981
election of Socialist president Francois Mitterrand. They contend that
such policies frightened investors,
triggered a massive outflow of
capital, and placed the franc under
tremendous pressure. By contrast,
peacetime nationalization of U.S.
businesses and industries is virtually unthinkable .
Most foreign exchange experts
agree, however, that American
political and economic stability
offer only a partial explana·tion for
the dollar's resurgence. The consensus seems to be that high U.S.
interest rates are primarily responsible for the strong dollar. As
long as "real" U.S. interest rates
remain high relative to interest
rates abroad, foreign demand for
U.S. financial assets will continue,
and the dollar will remain strong.
(The "real" interest rate represents
the difference between the
"nominal" or stated interest rate
and the rate of inflation.)
As high U.S. interest rates have
lured ever larger sums of foreign
capital to the United States, foreign
page 2

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Courtesy of Massport
A strong dollar lowers the price of foreign-made goods relative to the price of goods produced in
the United States.

political leaders have increasingly
pressured American policymakers
to cut U.S. budget deficits, bring
down U.S. rates, and intervene in
the currency markets in an effort to
force down the dollar's value. The
issue of currency market intervention has led to particular friction
between the United States and its
European allies.
In recent years, the U.S. Treasury has opposed regular currency
market intervention on the
grounds that such action would
probably/roduce only short-term
gains an could tend to forestall
needed changes in economic policies. But during the summer of
1983, currency trading threatened
to become "disorderfy," and the
United States agreed to participate
in a limited market intervention.
(In this instance, "disorderly" refers to sharp changes of the exchange rate between the dollar and
other currencies.) The U.S. Treasury directed the Federal Reserve
to act jointly with several West
European central banks, selling
dollars and buying marks and yen.
In a publication entitled Foreign
Exchange Markets in the United States
(see Multi-Media), Roger
Kubarych points out that this type
of central bank intervention creates
two effects. One is an ordinary
supply-and-demand effect; the
other is an effect on market expectations, on which he offers the
following observation:

Through the size, timing, and visibility of
their operations, monetary authorities provide
indirect information about official attitudes
toward current market exchange conditions.
Market participants may interpret the clues to
official attitudes in different ways. But they
rarely ignore them altogether when forming
their own decisions on whether to buy or sell a
currency.

According to an article in the August 16, 1983 edition of the Wall
Street Journal, traders generally regarded the well-publicized July/
August intervention as a "political
sop to the Europeans by an American administration that doesn't
really believe in such maneuvers."
Currency markets calmed down
somewhat after the intervention,
but the dollar continued its strong
performance.
Expectations, say many currency
traders, are nearly as important as
reality, and expectations are more
apt to be influenced by U.S. money
supply figures than by a very limited market intervention. When
the basic U.S. money supply increases, the dollar generally rises
against other currencies on the expectation that money supply
growth may lead to a more restrictive U.S. monetary policy and
higher U.S. interest rates. If,
however, money supply growth
continues unabated, the dollar
could slide on the fear that inappropriate money supply growth
might rekindle inflation.

Currency markets also respond
to projections of a high U.S. budget
deficit since traders generally expect that a high deficit will lead to
increased government borrowing
and higher U.S. interest rates.
High rates, in turn, attract foreign
capital and bolster an already
strong dollar.
European politicians voice particular concern over the large federal deficit because they believe a
large deficit keeps U.S. interest
rates "artificially"high and thereby
exerts upward pressure on European rates. This, of course, causes
political headaches for European
leaders since high rates make
Western Europe's economic recovery more difficult.
People on both sides of the
Atlantic would probably agree that
a slight drop in the dollar's value
would be a good thing for Europe
and the United States. Disagreement comes over what, if anything, could or should be done to
bring about such an outcome.
Some analysts back strong central
bank intervention in the currency
markets, whereas others favor letting market forces determine exchange rates. But an increasing
number of variables complicate
any international economic issue,
and the exchange rate question defies a simple answer. Indeed,
perhaps only one statement applies with any degree of certainty
to foreign exchange rates and currency markets: a lot of things can
change in five years.

New England
Update
CONNECTICUT
The Greater Hartford Center for
Economic Education at Central
Connecticut State College has
announced the schedule for its
1983-1984 Distinguished Speakers

Series.
• Tuesday, October 11, 1983,
7:00 p.m.
Theodore W. Schultz
1979 Nobel Laureate for
Economic Science
Professor of Economics,
University of Chicago
Theme: Education as a Long-term

Investment
• Thursday, February 23, 1984,
7:00 p .m.
Eli Shapiro
President, National Bureau of
Economic Research
Theme: Innovations in Financial
Institutions
• Thursday, March 29, 1984,
7:00 p .m .
Henry C. Wallich
Member, Board of Governors
of the Federal Reserve
System
Theme: Foreign Debt and
American Banks
All lectures are free and open
to the public; admission by ticket
only. For ticket information,
please call (203) 827-7318.

MAINE
The Maine Council on Economic
Education and the Foundation for
Teaching Economics will offer a 1day October workshop in the Portland area, and the University of
Maine at Orono will serve as the
location for a follow-up session to
the Council's summer course. The
Council will also run a series of fall
workshops in Hampden as part of
the DEEP program. For details on
the Council's fall activities, please
contact: Robert Mitchell, Executive
Director, Maine Council on Economic Education, 22 Coburn Hall,
Orono, ME 04469; (207) 581-1467.
MASSACHUSETTS

The Economic Education Council of Massachusetts (EECM) has
elected James F. Connors its new
part-time executive director and relocated its headquarters from
Hingham to Boston. (New address
and phone: Economic Education
Council of Massachusetts, 14
Beacon Street, Suite 613, Boston,
MA 02108. Phone: 227-6691.)
Mr. Connors, who heads his
own public relations firm of James
F. Connors & Associates, succeeds
retiring EECM executive director
Daniel W. Gibbs, Jr.
The EECM also has a new chairman. Frank LeBart of the John
Hancock Mutual Life Insurance
Company succeeds outgoing chairman Al Peckham.

Multi-Media
FOLLOW-UP

1) How does a strong dollar
affect the U .S. inflation
rate?
2) Many economists believe
that inappropriate, unrestrained money supply
growth leads to inflation. If
the Federal Reserve adopts
a more restrictive monetary
policy in response to higher
than expected money supply growth, currency traders might then expect the
dollar to rise against other
currencies. Why?
3) If the U.S. money supply
grows at an inappropriate
rate and the Federal Reserve decides not to adopt a


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more restrictive monetary
policy, the dollar could slide
on the fear that inappropriate money supply growth
might rekindle inflation.
Why might traders expect a
higher U.S. inflation rate to
signal a weaker dollar?
4) A larger federal deficit
almost always means that
the U.S. government must
borrow more money. Why
might a large deficit lead to
higher interest rates and a
stronger dollar?
5) How do high U.S. interest
rates put upward pressure
on European interest rates?

Foreign Exchange Markets in the
United States, Revised Edition; written by Roger M. Kubarych, published by the Federal Reserve Bank
of New York.
More and more people are becoming aware of the important implications that changes in the dollar's value have for output, employment, and the price level in the
United States as well as abroad.
Few firms can overlook increasing
global interdependence and the
impact it has on everyone's livelihood.
Roger Kubarych, senior vice
president and deputy director of
research at the Federal Reserve
Bank of New York, has updated
Foreign Exchange Markets in the United States with two objectives in
Continued on Page 4

page 3

mind: to keep it accurate, readable,
and accessible to a wide audience;
and to give a flavor of how the foreign exchange markets have
evolved since the late 1970s. The
SO-page booklet is available at no
charge from the Public Information
Department, Federal Reserve Bank
of New York, 33 Liberty Street,
New York, NY 10045.
Your Credit Rights, published by
the Federal Reserve Bank of Minneapolis.
Your Credit Rights has been developed for use with secondary
and post-secondary students and
adults studying consumer credit
and consumer credit protection
laws. Sections included are: 1) An
overview of Consumer Credit; 2)
The Equal Credit Opportunity Act;
3) The Fair Credit Reporting Act; 4)
The Fair Debt Collection Practices
Act. Two more sections are currently being developed: 1) Truth in
Lending; and 2) The Fair Credit
Billing Act.
Each section contains several
learning activities and a variety of
teaching strategies to meet the instructional objectives. Activity instructions, vocabulary, key concepts, answer keys, masters for
making overhead transparencies
and classroom sets of all student
materials are included.
Your Credit Rights can be placed
in a three-ring binder allowing removal of sections or individual
sheets for lesson preparation and
classroom use .
To order Your Credit Rig'hts please
write to Office of Public Information, Federal Reserve Bank of Minneapolis, 250 Marquette Avenue,
Minneapolis, MN 55480 or call
(612) 340-2446. (One free per instructor)
Banking Regulation: Its Purpose,
Implementation, and Effects; written by Kenneth Spong, published
by the Federal Reserve Bank of
Kansas City.
Commercial banking in the United States has long been subject to
regulation . This regulation has
undergone many changes and
evolved to the point where nearly
every aspect of banking is reviewed by a supervisory authority.
The general public, bankers, politicians, and regulators have all played roles in developing the present
system of banking laws and supervision. As a consequence, the regulatory system now has a signifi-

page 4


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Fed Update
MIDDAY MUSIC AT THE
FEDERAL RESERVE BANK OF BOSTON

A series of midday musical programs continues at the Federal Reserve Bank
of Boston's auditorium. All performances begin at 12:30 p.m. and are 30-40
minutes in length. The public is invited at no charge.
The remaining schedule is as follows:
Thursday, October 6
- Boston University
Back Bay Brass
Thursday, October 13
- New England Conservatory
- Susan Lauck, piano
Tuesday, October 18
- New England Conservatory
Thursday, October 27
- Boston University School of Music
Thursday, November 3
- Longy School of Music
Thursday, November 10
Longy Wind Ensemble
Basil Chapman, conductor
- Boston University School of Music
Tuesday, November 15
- Concert Dance Company of Boston
Thursday, December 1
- The New Ehrlich Theater
Thursday, December 8
The Royal Paste and Paper Circus
- New England Conservatory
Thursday, December 15
The auditorium is located on the ground level of the Reserve Bank at 600
Atlantic Avenue, across from South Station.
Programs are subject to change without notice.
MONEY FUN FOR EVERYONE

NO CHARGE

The Federal Reserve Bank of Boston is hosting a morning of Money
Fun For Everyone on December 28,
1983 from 9:30 a.m. to 11:30 a.m.
The free program is geared to children of afl ages and their parents. It
will feature a variety of educational
activities, a tour of the Money Department, a view of Boston from
the Bank's 31st floor, and light refreshments.
Space is limited and preregistration is a must. For reservations,
please call 973-3452. All children
must be accompanied by an adult.

The Federal Reserve Bank of Boston will no longer charge a rental
fee for 16mm films.

cant influence in determining the
types of banking services available
to the public.
Banking Regulation: Its Purpose,
Implementation, and Effects describes
the bank regulatory system and its
influence on the banking system. It
also provides a per_spective on how
banking regulation evolved and
the purpose it serves. Finally, it
outlines many of the changes taking place in banking today and
their implications for banking regulation.
Copies of this clearly written 150page book are available at no
charge from the Public Affairs Department, Federal Reserve Bank of
Kansas City, 925 Grand Avenue,
Kansas City, MO 64198.

SURVEY

We are trying to make our
audiovisual materials available
to an even greater number of
schools and organization,s .
You can help us by completing
the enclosed survey card and
returning it to us before December 31, 1983.

the LEDGER
Editor: Robert Jabaily
Graphics Arts Designer: Ernie Norville
Photography: Wilson Snow
Johannah Miller
This newsletter is published periodically as
a public service by the Federal Reserve Bank
of Boston. The reporting of news about
economic education programs and
materials should not be construed as a
specific endorsement by the Bank. Further,
the material con tained herein does not
necessarily reflect the views of the Federal
Reserve Bank of Boston or t/,e Board of
Governors. Copies of this newsletter and a
catalogue of other educational materials
and research publications may be obtained
free of charge by w riting: Bank and Public
Information Center, Federal Reserve Bank
of Boston, Boston , MA 02106, or by
calling: (617) 973-3459.