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6:30 P.M. E.S.T.


Remarks of

Philip E. Coldwell
Board of Governors
of the
Federal Reserve System

Before the

Inter-American Symposium on
Financing And Credit in Foreign Trade

Miami, Florida
December 6, 1978

From August of 1977 to last November 1 we witnessed a pre­
cipitous decline in the international value of the dollar and a
corresponding escalation of the exchange values of a number of foreign
currencies - notably the Japanese yen, the Swiss franc and the German

Over that period, to the low point for the dollar on October 30,

the weighted average value of the dollar against ten leading foreign
currencies dropped by over 20 per cent.

That is an enormous change -

far exceeding any differential in inflation rates.

Over the same period

the yen rose over 50 per cent against the dollar, the Swiss franc jumped
by 64 per ccnt, and the German mark by 34 per cent.

Moreover, countries

whose currencies were appreciating against the dollar bought over $30
billion in an effort to stabilize exchange markets and resist further
These are extraordinary changes in exchange rates in little
over a year, clearly symptomatic of serious imbalances and uncertainties
in international economic relationships.

I would like to explore with

you today some of the factors underlying those developments, as well as
the remedies that have been set in motion by recent actions here and
Perhaps the most important underlying factor has been the di s­
crepancy between the rate of economic growth in the United States and in
other industrial countries since the recession of 1975.

In the case of

the United States we have seen sustained growth, with industrial



production now 25 per cent above the 1975 low, and 7 per cent above the
level in the third quarter of 1977 when the decline of the dollar began.
In the six leading foreign industrial economies, industrial production
is about 15 per cent above the recession lows, and the rise since the
third quarter of 1977 has been only 3 per cent.

An even greater d i f ­

ference shows up in the employment data-- over the past two years we
have absorbed 6 million new workers into the labor force, and have
reduced the unemployment rate from 7-1/2 per cent to 6 per cent.

In the

six foreign economies aggregate unemployment has risen throughout this

While excess capacity has gradually been reduced in the United

States, and we are probably close to effective capacity in a number of
sectors, the general picture in industries abroad has been one of c o n ­
tinued substantial excess capacity.

This difference in economic p e r ­

formance has been a major factor in the greatly enlarged trade deficits
of the United States.
Another factor in the decline of the dollar has been our
difficulty in bringing inflation under control.

From the third quarter

of last year to the third quarter of 1978 consumer prices in the United
States rose by 8 per cent; in recent months the rate of increase has
been 10 per cent.

At the other end of the spectrum, consumer prices in

Germany, Switzerland and Japan are only between 1 and 4 per cent higher
than they were a year ago, and they have not tended to accelerate in
recent months.

These discrepancies in inflation rates are magnified as

they work through the economic system.

They offset some of the


competitive advantage gained through the steep depreciation of the
dollar, they lead to expectations of further appreciation of the cur­
rencies of the less-inflationary countries, which feeds back into
further pressure on the dollar, and the changes in the exchange rates
themselves reduce the pressure of price inflation in appreciating
countries while making the problem of the United States even more
A third factor is our failure to take measures to curtail fuel

As you know, those imports jumped from about $8 billion a year

prior to the price increase in 1973 to about $45 billion in 1977.


year the entry of Alaskan oil into the picture gave us a temporary
levelling off in the rate of imports, but right now such imports are
estimated to be back to the $45 billion level, and we face the prospect
of rising quantities and prices in the year ahead.

It is true that we

are beginning to move toward a more effective energy policy, but imple­
mentation will take time, and in the interim exchange markets will be
influenced by the fact that we must find the means to pay for these
The economic developments that I have described bear directly
on our trade balance --probably the most widely watched indicator of our
international economic vitality.

Over the past few years our interna­

tional trade record has been disastrous --as recently as the first half
of 1976 our trade deficit was about a $6 billion annual rate; by the
third quarter of 1977 the deficit rate was $29 billion, and it ballooned

to a rate of over $40 billion in the fourth quarter of 1977 and the first
quarter of this year.

Deficits like these clearly undermined market co n­

fidence in the future of the dollar.

At present the deficit rate is

down to about $31 billion, and we expect it to decline considerably
next year.

Nevertheless, deficits of this size continue to unsettle

exchange markets.
Let us look at some of the major changes in exports and imports
that make up the $22 billion rise in the deficit from 1976 to the present.
Exports over that period rose by $34 billion, while imports increased
$55 billion.

On the export side agricultural products have done well--

advancing about $9 billion, with volume up about one third and prices
up only slightly.

Non-agricultural exports, however, have not done so

While prices of such exports rose by about 17 percent, until the

most recent months

their volume was scarcely above the 1976 levels

in fact was no higher than it was in 1974,


This is a clear indication

of the impact of the slow recovery in economic activity abroad -especially in the investment sectors that are so important for our
exports of capital goods.
We see an even stronger consequence of the difference in eco­
nomic performance when we look at what has happened to our imports.


I noted above we had a temporary reduction in fuel imports when Alaskan
oil started to come in, but our fuel imports now are about $19 billion
higher at an annual rate than they were in 1976.

It is in the non-oil

imports, however, that the greatest jump has occurred -- from about



$90 billion in 1976 to a current rate of over $125 billion.

Over that

period we have had a 25 per cent increase in the volume of non-oil
imports, and about a 20 per cent increase in prices.

The bulge in the

volume of imports covered a broad spectrum of products -- basic m a t e ­
rials and metals, such as steel, as well as foods, capital goods, autos,
and all kinds of consumer goods.
Some of the explanation for this surge in imports is selfevident - " t h e rising level of demand in the United States coupled with
excess productive capacity abroad.

In the earlier part of the period

the dollar was relatively strong and this helped to accelerate exports
to the United States.

There are also the intangibles-- the export

orientation of major industries abroad, the slide in productivity here
relative to foreign experience, and perhaps the foreign non-tariff
barriers against U.S. goods which have had a greater effect
than the ones we imposed.

I hope that the current multilateral trade

negotiations will succeed in reducing those barriers so that we do not
adopt the ultimately self-defeating tactic of reciprocal protectionism.
Just as we can find an explanation for the weakness of the
dollar in the trade deficits of the United States, we can find much of
the explanation of the strength of the German mark and the Japanese yen
in the trade balances of these countries.

In the case of Germany, the

trade surplus was $13-1/2 billion in 1976, but is now at an annual rate
of over $22 billion.

For Japan the trade surplus was just under $10

billion in 1976 while it is currently at a rate of about $27 billion.
These enormous contrasts with the U.S. experience are simply
not compatible with stable exchange rates.



While the trade imbalances set up expect*t:i.ons of exchange
rate Changes, the size and the speed of pressure« on exchange rates
are 6 reflection of the huge fund of liquidity ready to shift from
dollar assets to other Assets.

I would not want to overstate this

problem by citing data on the gross size of the Et»ro--dollar markets.
After all, a large part of the recorded balances i.6 interbank b u s i ­
ness rather than asset holdings or liabilities of ultimate lenders and

It should be remembered that most of the participants on

both sides of the market are foreign --which means that an attempt by
holders of Euro-dollar deposits to shift into other currencies must be
accommodated largely by running down dollar-denominated credits to
foreign borrowers.

However, even though some measures of the stock of

dollars available for rapid conversion into foreign currencies may be
exaggerated, there can be no doubt that the amount of liquidity avail­
able to both Americans and foreigners is enormous*

Moreover, massive

short-term pressures can be brought to bear merely by shifting the
terms of payments for goods and services — the so-called leads and lags.
Thus the potential for shifting away from dollar assets is sizeable and
constitutes a destabalizing overhang w h i c h will threaten Exchange rate
relationships until measures are taken to reassure the public that the
dollar's purchasing power will not erode further.
The President announced on November 1 a program designed to be
powerful enough to convince the market that the dollar would not be
allowed to drop further.
program are as follows:

Briefly summarized, the major aspects of that



On monetary policy, the Federal Reserve acted by

raising the discount rate a full per cent to 9-1/2 per cent and by
imposing a 2 per cent supplementary reserve requirement on large
denomination time deposits.

That substantial dose of monetary

restraint was attuned to the severity of our inflation problem and
also was consistent: with the need to reassure exchange markets that
resistance to deterioration of the dollar would be given a high

A number of other actions designed to provide funds to

support the dollar were also announced:

an increase of $7.6 billion

to $15 billion in the swap arrangements with Germany, Switzerland and
Japan, and activation of the swap line with Japan; a drawing of $3
billion worth of strong currencies on the United Stac£s reserve
position in the IMF; the use of $2 billion equivalent of SDRs owned
by the United States to purchase currencies useable for market inter­
vention; and plans to raise up to the equivalent of $10 billion of
foreign currencies through the sale of U.S. Treasury foreigncurrency obligations.

These measures bring to $30 billion the ammuni­

tion available for intervention in foreign exchange markets and we
pledged forceful intervention to stabilize the market.

In addition,

the Treasury will raise its gold auctions to at least 1,500,000 ounces
per month from the previously announced 750,000 ounces.

For their part, authorities in other countries have under­

taken vigorous market intervention to support the U.S. actions, and
have pledged their cooperation to restore stability in exchange markets.


Since the low point of October the average value of the dollar
has gained about 7 per cent, almost to the level at the beginning of the

Against the German mark, Japanese yen, and Swiss franc the gains

have been 10, 6, and 11 per cent, respectively.

However, as usual, the

market is waiting to be shown that official programs will actually
deliver the desired results.

What is the evidence that is likely to

convince the market that the dollar is strengthening?
The most effective direct evidence would be a consistent
reduction in U.S. trade deficits.

For that to happen there will need

to be a reversal of the cyclical pattern described earlier.

The U.S.

position can best contribute to this by achieving a slow growth path
that is steady and stable and avoids pressure on our productive capac­

With persistence and strong citizen support present policies can

achieve such a path for the United States.

Cooperative and complementary

actions are also needed from other industrial countries whose recovery
from the recession has been far from vigorous.
there are grounds for expecting improvement.

On this score, too,
Germany and Japan, in

particular, have recently adopted fiscal measures aimed at reinvigorating their economies and these measures should start to have an .ifect
next year.

Moreover, authorities abroad are expected to carry through

with additional measures should their growth paths remain sluggish.
As a consequence of these complementary policy moves, the
growth rate of the United States economy in 1979 is expected to be some­
what lower than the estimated 4 per cent pace of 1978, while the growth



rate of the leading foreign economies should advance to about 4 per cent
in 1979 from only about 3 per cent this year.

As these growth rates

intersect, U. S. exports should increase but imports be retarded.


fact, recent months have already seen a pickup in the volume of exports
although these recent changes probably result more from the sharp depre­
ciation of the dollar over the past year than to a shift in relative
economic growth rates.
On the inflation front the United States obviously has a
tough task ahead.

As noted, the rate of inflation in this country in

recent months has considerably exceeded the rate in a number of our c om­

However, inflation rates abroad may rise a bit as demand picks

up, and as the benefits of currency appreciation diminish, while an end
to the depreciation of the dollar would reduce inflationary processes
in the United States.
Taking these potential trends into account, there could be a
material reduction in the U.S. trade deficit, though there may be months
of erratic movements.

Projections in this area are always hazardous,

but I would anticipate a substantial decline next year from the current
$30 billion rate.

It is also worth keeping in mind that the United

States has a large and growing surplus in the non-goods sector of its
international current account, especially from the return on foreign

Including these receipts, our current account balance --

covering goods, services, and unilateral transfers —

is estimated to

bo in deficit by less than $20 billion this year, and mny be at half
that rate in the closing months of 1979.

-1 0 -

We are now only at the beginning of the process of restoring
equilibrium to international financial markets.

What happens in those

markets is important to us because uncertainties there feed back into
our economy, holding down investment and driving up our inflation rate.
An improved trade balance would also directly support our economy as
we move to slow the raLe of growth of domestic demand.

It is sometimes

overlooked that our exports are now an important part of total U.S.
production accounting for over 11 per cent of all goods produced.


broadly, however, sustained reduction in our trade deficits would be a
signal to the n.arket that we are making progress on the fundamental
problems of our economy.

There is an especially delicate balance of

risks in slowing the growth of the economy and slowing the rate of

But in my view, slowing inflation is critically needed not

only to restore equilibrium internationally but also as a precondition
for continued healthy growth at home.
Therefore, I repeat before this audience some of the actions
I recommended in early simmar and again in October.
First, additional fiscal restraint must be applied not only
because it is needed to reduce inflationary pressures but also because
it has become a domestic and international flag bearer for market c o n ­

A cut of 10 per cent in government spending is the minimum

we should accept but to do this you and I must reduce our demands on

-1 1 -

Second, spending cuts should permit a margin of revenue to
be used to spur new investment in plant and equipment to modernize our
productivity capacity and generate new jobs and to encourage a lower
rate of wage increase.
Third, we should lift the straight jacket of interest rate
controls both at federal and state levels so that our people can be
paid a positive rate for savings not the negative rates presently

Only by encouraging saving can we amass the needed funds for

new long-term capital investment even though this will reduce the per
cent of disposable income dedicated to current consumer spending.


we are to keep up with our foreign competitors, especially Germany and
Japan, a strong and sustained capital spending program is not a luxury
but a critical necessity.

It may mean that we give up some present

consumer spending but it will insure a long run competitive vitality
without which the United States will become a second class economic
power producing very little and consuming products manufactured abroad.
Fourth, the United States needs a strong energy program of
conservation and new production of both old and new types of energy
preferably financed by the private sector and stimulated by rapid
investment tax write-offs and lower capital gains taxes.

But if it

takes more direct government effort a program of government loan guar­
antees, low rate loans, or even price and market guarantees could be
a means of accelerating investment in energy exploration, production
and new development.

Again the economic and political strength of the

United States could ride on this too long delayed effort.



Finally we must have the political and public strength and
support to sustain monetary restraint even in the face of modest
reverses of growth rate or unemployment, for the strength of the dollar
at home and abroad is critical to our place in the economic world.


can no longer afford to restimulate our economy at the first sign of
reverses nor accelerate its growth to levels sharply above those of
our prime foreign competitors.
It must be obvious that, in my opinion, we in the United States
face a series of challenges the solutions to which will probably set
our course for years to come either toward continued greatness or
fading glory.

Do we have the collective will to forego short run

excesses in consumption, plan for a stronger productive future, and
take our medicine for past mistakes?

I believe we do if the choices

are explained and the challenges are given the highest priority in the
decision making of consumers, businesses, and governments.
The success or failure of the United States in getting its
economic house in order will be of importance to all our trading
partners and to all who use the dollar as a transaction currency or
an integral part of their international reserves.

The impacts can be

viewed in both short- and long-run dimensions.
If the United States is not successful in bringing its
inflation rate under control or cannot reduce its balance of trade
deficit, the value of the dollar would likely depreciate further,
causing additional instability in the international financial markets
and damaging the reserve currency characteristics of the dollar.


However, if; as I believe, the United States will be success­
ful in reducing both its balance of trade deficit and its inflation
rate, there will be an obvious impact in the form of reduced imports
into the United States, and/or higher exports from the United States
which will create adverse short-run effects on the payments position
of our trading partners.

But in the long run the improved stability

of the dollar and its value as a reserve currency would be enhanced
and, in my view, this will strengthen the international monetary system
to the benefit of all participants.

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