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WHAT IS HAPPENING TO
ADDRESS BY ROBERT P.

THE

U.S.

DOLLAR?

MAYO, PRESIDENT,
rEDERAL RESERVE BANK OF CHICAGO
AT THE MEETING OF THE lNTERNAIIONAL TRADE CLUB OF CHICAGO
1-EBRUARY Y, 19/8
WHEN YOUR CHAIRMAN CALLED ME SOME TIME AGO AND ASKED IF

I

WOULD TALK TO YOU ON THE TOPIC "WHAT IS HAPPENING TO TME DOLLAR?",

I WAS REMINDED OF AN OLD STORY l HEARD ONCE ABOUT MR, MONTAGUE
l·iORMAN, THE LONG-TIME GOVERNOR OF THE BANK OF ENGLAND,

BACK IN

1919, SO THE STORY GOES, MR, NORMAN WAS ATTENDING A MEETING WITH
THE BANKERS OF THE CITY OF LONDON, THE POUND HAD JUST BEEN TAKEN
OFF GOLD AFTER MORE THAN A CENTURY OF BEING THE UNDISPUTED, STABLE
INTERNATIONAL STANDARD OF VALUE,

IT WAS FLUCTUATING WIDELY IN

VALUE AGAINST THE DOLLAR AND OTHER CURRENCIES,

THIS WAS, OBVIOUSLY,

A NEW, SHOCKING EXPERIENCE TO MANY BANKERS IN THE CITY,

THEY

BESIEGED MR, NORMAN WITH COMPLAINTS DEMANDED AN EXPLANATION AS TO
WHAT WAS HAPPENING TO STERLING,

MR, NORMAN IS SAID TO HAVE MOUNTED

THE PODIUM AND WITH A SOLEMN VOICE TO HAVE DECLARED:
ASSURE YOU THE POUND IS STEADY AS A ROCK,

11

I

GENTLEMEN,

Ir's JUST THOSE BLOODY

FOREIGNERS WHO HAVE LOST CONTROL OF THEIR EXCHANGE RATES, 11
TODAY, IN TALKING ABOUT 11 WHAT IS HAPPENING TO THE DOLLAR?"
WISH,

I

I COULD GIVE YOU, IN GOOD CONSCIENCE, A SIMPLE, "AUTHORITATIVE 11

ANSWER LIKE THAT--WITHOUT BEING FACETIOUS, AS OBVIOUSLY MR, NORMAN
WAS,

THE FACT OF THE MATTER IS, AS YOU KNOW WELL, THAT THE DAILY

FLUCTUATIONS AND LONG-RUN TRENDS IN THE INTERNATIONAL VALUE OF THE
DOLLAR--AND IN THE VALUE OF INDIVIDUAL CURRENCIES IN TERMS OF THE
DOLLAR--ARE THE PRODUCT OF A GREAT MANY FORCES,


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SOME ARE ECONOMIC

- 2IN ORIGIN AND SOME ARE PSYCHOLOGICAL. SOME ARE BASED ON RATIONAL
AND SOME ON IRRATIONAL EXPECTATIONS OF MOVEMENTS IN PRICES,
INTEREST RATES, FLOWS OF TRADE, POLITICAL DEVELOPMENTS, BUSINESS
PROSPECTS, AND MANY OTHER FACTORS,

MOVEMENTS IN THE EXCHANGE

RATE ARE LIKE THE MOTION IN THE TIP OF AN ICEBERG--THE RESULT OF
MOVEMENTS IN THE UNDERLYING MASS WHICH ARE OBSCURED FROM CLEAR

5o, IN ANSWERING THE QUESTION POSED BY THE TITLE OF MY

VIEW,

TALK, IT SEEMED TO ME THAT l SHOULD EXPLORE WITH YOU SOME OF THE
Ul~DERLYING FACTORS IN THE MOVEMENT OF THE EXCHANGE RATE OF THE
DOLLAR, THEIR ORIGINS, AND THEIR FUTURE TRENDS AS I SEE THEM,
LET'S TAKE A LOOK FIRST AT WHAT HAS BEEN HAPPENING TO THE
DOLLAR IN TERMS OF SOME COLD STATISTICS,

l.AST YEAR, THE DOLLAR

DEPRECIATED SHARPLY AGAINST SEVERAL MAJOR CURRENCIES,

IT DROPPED

18 PERCENT IN VALUE RELATIVE TO THE SWISS FRANC AND
JAPANESE YEN, BY ABOUT 11 PERCENT RELATIVE TO THE GERMAN MARK,
AND BY ABOUT 10 PERCENT RELATIVE TO THE BRITISH POUND, THESE
BY ABOUT

~/ERE THE MOVEMENTS THAT ATTRACTED A GREAT DEAL OF PRESS COVERAGE
AND PUBLIC ATTENTION,

HOWEVER, THE PRESS LARGELY IGNORED THE

FACT THAT THE DOLLAR REMAINED RELATIVELY STABLE AGAINST SOME
OTHER MAJOR CURRENCIES, AND THAT IT GAINED AGAINST SOME OTHERS,
AS, FOR EXAMPLE, THE CANADIAN DOLLAR.

INDEED, USING A BROADER

MEASURE OF THE IN THE EXCHANGE VALUE OF THE DOLLAR THAT TAKES
INTO CONSIDERATION THE CURRENCIES OF OUR 15 MAJOR TRADING PARTNERS WEIGHTED BY THEIR RELATIVE TRADING IMPORTANCE--THE TRADEWEIGHTED EXCHANGE VALUE--WE FIND THE DOLLAR HAS DEPRECIATED BY
ONLY ABOUT

4 1/2

PERCENT OVER THE PAST YEAR,

THIS, CERTAINLY,

HAS NOT BEEN A CATACLYSMIC DEPRECIATION--AS SOME MARKET OBSERVERS


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Federal Reserve Bank of St. Louis

- 7

)

WOULD MAKE US BELIEVE--PARTICULARLY WHEN IT IS REALIZED THAT EVEN
WITH THAT DEPRECIATION THE DOLLAR IS NOW STILL WORTH MORE IN
TERMS OF THOSE

15 CURRENCIES THAN IT WAS FIVE YEARS AGO! WITH

THAT PERSPECTIVE IN MIND, LET'S LOOK AT THE UNDERLYING CAUSES OF
THESE MOVEMENTS,
tVEN AT THE RISK OF DWELLING ON FACTS THAT WILL BE FAMILAR
TO MOST OF YOU, l THINK A GOOD WAY TO START IS BY EXAMINING SOME
OF THE "FUNDAMENTALS" OF THE SITUATION--THE WORKING OF THE
INTERNATIONAL MONETARY SYSTEM THAT PROVIDES THE FRAMEWORK WITHIN
WHICH EXCHANGE RATES ARE GENERALLY ESTABLISHED,
SINCE EARLY

1973, THE FREE WORLD HAS BEEN OPERATING UNDER A

FLOATING RATE SYSTEM,

THIS SYSTEM CAME INTO BEING FOLLOWING THE

COLLAPSE OF BRETTON WOODS IN

1971, AND AFTER MANY MONTHS OF

FUTILE EFFORTS TO REESTABLISH FIXED EXCHANGE RATES,
PERFECT SYSTEM,
PAST,

IT IS NOT A

WE HAVE BEEN REMINDED OF THIS REPEATEDLY IN THE

AND SOME OF THE MOST RECENT DEVELOPMENTS CERTAINLY BEAR

THIS OUT,

Bur

I THINK WE HAVE TO RECOGNIZE THAT THE FIXED EXCHANGE

RATE SYSTEM HAS PASSED FROM THE WORLD STAGE, AND THE FLOATING
SYSTEM IS VERY PROBABLY HERE TO STAY,
THE MAIN FEATURE OF THE FLOATING EXCHANGE RATE SYSTEM IS, OF
COURSE, THAT THE EXCHANGE RATES OF INDIVIDUAL CURRENCIES ARE
PERMITTED TO MOVE RELATIVELY FREELY IN RESPONSE TO THE FORCES OF
SUPPLY AND DEMAND,

AN IMPORTANT SOURCE OF DEMAND FOR, AND THE

SUPPLY OF, A COUNTRY'S CURRENCY IN A FREE-MARKET ECONOMY IS THE
MYRIAD OF TRANSACTIONS THAT INDIVIDUALS AND CORPORATIONS RESIDING
IN A COUNTRY ENGAGE IN, DAY-IN AND DAY-OUT, WITH RESIDENTS OF
OTHER COUNTRIES,


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Federal Reserve Bank of St. Louis

IN THE CASE OF THE U,S, DOLLAR, FOREIGNERS WHO

- 4 -

BUY OUR PRODUCTS, SERVICES, AND OUR SECURITIES NEED DOLLARS TO
MAKE PAYMENTS TO US, THEY ARE A SOURCE OF DEMAND FOR DOLLARS ON
THE FOREIGN EXCHANGE MARMENTS,

ON THE OTHER SIDE, THERE ARE

U.S.

RESIDENTS WHO PURCHASE FOREIGN GOODS, SCRVICES, INVESTMENTS, AND
SECURITIES, AND PAY FOR THEM IN DOLLARS; THEY ARE A SOURCE OF
SUPPLY OF DOLLARS

THE FOREIGN EXCHANGE MARKETS,

ON

OTHER SOURCES OF SUPPLY AND DEMAND DERIVE FROM THE SPECIAL
POSITION OF THE DOLLAR IN INTERNATIONAL FINANCE,
11

HAS BEErJ FOR MANY YEARS AN

THE ~.S, DOLLAR

INTERNATIONAL CURRENCY. 11

Ir HAS

BEEN

USED AS A CURRENCY OF SETTLEMENTS OF TRANSACTIONS AMONG MANY
COUNTRIES OUTSIDE THE UNITED STATES AND AS AN OFFICIAL RESERVE
ASSET,

THIS ROLE HAS LED TO A LARGE DEMAND ON THE PART OF OFFICIAL

INSTITUTIONS, AS WELL AS PRIVATE INDIVIDUALS AND CORPORATIONS
AEROAD, FOR DOLLARS TO EE MELD FOR TRANSACTIONS PURPOSES AS WELL
THE EXISTENCE OF THE t200 BILLION

AS A STOREHOUSE OF VALUE,

[URODOLLAR MARKET--WHERE DOLLARS ARE HELD, LENT, AND BORROWED FOR
A VARIETY OF PURPOSES--IS ONE MANIFESTATION OF THE SCOPE OF THAT
DEMAND,

THE

CO

OR SO BILLION DOLLARS HELD BY THE FOREIGN OFFICIAL

INSTITUTIONS IS ANOTHER,

THIS FOREIGN DEMAND FOR DOLLARS HAS

BEEN MOTIVATED NOT ONLY EY MARKET--ORIENTED CONSIDERATIONS, BUT
ALSO BY PSYCHOLOGICAL, POLITICAL, AND EXPECTATIONAL FACTORS,
RESULTING FLUCTUATION IN "HOARDING'' AND

11

THE

DISHOARDING" OF PRIVATELY

HELD DOLLARS AEROAD HAS, ON OCCASION, BEEN AN IMPORTANT ELEMENT
INFLUENCING THE SUPPLY OF, AND THE DEMAND FOR, DOLLARS ON THE
FOREIGN EXCHANGE MARKETS--AND THUS THE MOVEMENTS OF THE EXCHANGE
RATE OF THE DOLLAR IN TERMS OF OTHER CURRENCIES,

So

MUCH, THEN, FOR THE

NOW TRY TO PUT SOME

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11

11

BASICS 11 OF THE SITUATION,

LET ME

MEAT 11 ON THIS BASIC SKELETON BY TRACING SOME

- 5 OF THE SOURCES OF THE SUPPLY OF AND DEMAND FOR DOLLARS AS THEY
HAVE EMERGED IN THE REAL WORLD AROUND US,
OVER THE PAST THREE YEARS, WE EXPERIENCED THE DEVELOPMENT OF
A MAJOR IMBALANCE IN OUR INTERNATIONAL ACCOUNTS,

OUR TRADE

ACCOUNT SHIFTED FROM A $9 BILLION SURPLUS IN

TO A DEFICIT OF

$9 BILLION IN 1976, AND TO MORE
1977 ON THE BALANCE-OF-PAYMENTS

1975

THAN A $31 BILLION DEFICIT IN
BASIS, THIS DEFICIT IN TRADE IN

GOODS WAS PARTIALLY OFFSET BY OUR TRADE IN SERVICES (~HICH INCLUDES
RETURN ON OUR INVESTMENTS ABROAD) BUT IT STILL LEFT US WITH AN

$18

BILLION DEFICIT ON THE SO-CALLED CURRENT ACCOUNT,

THAT WE HAVE SUPPLIED

$18

THIS MEANT

BILLION MORE TO THE FOREIGN EXCHANGE

MARKETS THROUGH PAYMENTS FOR THESE TRANSACTIONS, THAN WAS DEMANDED
BY FOREIGNERS TO PAY FOR THEIR TRANSACTIONS,

THE TRADE DEFICIT

THUS REPRESENTED ONE IMPORTANT KNOWN ELEMENT OF THE EXCESS SUPPLY
IN THE EXCHANGE MARKETS,

WHAT HAVE BEEN THE UNDERLYING CAUSES OF

THAT DEFICIT, AND HOW CAN WE DEAL WITH THEM?
THE UNDERLYING CAUSE OF OUR BURGEONING TRADE DEFICIT HAS
BEEN A FASTER GROWTH IN OUR IMPORTS THAN IN OUR EXPORTS,
OUR IMPORTS WERE UP BY ALMOST

22

CREASED BY LESS THAN 5 PERCENT,

PERCENT IN

1977,

WHILE

OUR EXPORTS IN-

THIS RAPID RATE OF GROWTH IN

IMPORTS WAS KEENLY FELT IN CERTAIN SECTORS OF OUR INDUSTRY AS
FOREIGN PRODUCTS SUCH AS STEEL, SHOES, TELEVISION SETS, AND CARS
MADE DEEPER INROADS INTO OUR DOMESTIC MARKETS,

As

A RESULT, WE

HAVE WITNESSED A GROWING PRESSURE FOR IMPORT RESTRICTIONS AS A
MEANS OF SOLVING THE PROBLEMS OF THE AFFECTED INDUSTRIES, AS WELL
AS OF OUR GROWING DEFICIT,

OUR GOVERNMENT USED AND IS USING

EXISTING CHANNELS DEVELOPED THROUGH


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Federal Reserve Bank of St. Louis

U.S.

LAWS AND INTERNATIONAL

- 6 -

TREATIES TO DEAL· WITH LEGITIMATE COMPLAINTS OF INDIVIDUAL INDUSTRIES AGAINST UNFAIR FOREIGN COMPETITION,

Eur

WE MUST NOT

PERMIT OURSELVES TO ACT UNILATERALLY IN REGARD TO OUR IMPORT
PROBLEMS BY THE IMPOSITION OF ARBITRARY IMPORT RESTRICTIONS!
FEW, IF ANY, NATIONS WOULD TOLERATE SUCH MEASURES!
MISTAKE,

IHEY WOULD RETALIATE,

PROTECTIONISM,

MAKE NO

PROTECTIONISM INVITES MORE

AND THE SPREAD OF IMPORT RESTRICTIONS THAT WOULD

FOLLOW WOULD DO A GREAT DAMAGE TO THE
OUR WORLDWIDE NATIONAL INTERESTS!

U.S.

ECONOMY AS WELL AS TO

IF WE WANT TO FIND A LASTING

SOLUTION TO OUR TRADE PROBLEMS, WE MUST LOOK DEEPER INTO THE
~

-·-----

O _:ff

UNDERLYING CAUSES AND SEEK THE SOLUTIONS THERE,

o~- ro ttu

~

..

PROllA.BL¥ 4TME MO&T,tIMPORTANT UNDERLYING CAUSE50F THE RAPID
EXPANSION IN OUR IMPORTS RELATIVE TO OUR EXPORTS HAS BEEN THE
RECENT WIDE VARIATION AMONG THE FREE WORLD NATIONS IN ECONOMIC
PERFORMANCE,

OUR ECONOMY HAS BEEN HEALTHIER, AND GROWING CON-

SIDERABLY FASTER, THAN THE ECONOMIES OF OUR MAJOR TRADING PARTNERS TAKEN AS A GROUP,

THE EXPANDING

U.S.

ECONOMY HAS BEEN

DRAWING IN IMPORTS AT A MORE RAPID CLIP THAN HAS BEEN THE RATE OF
GROWTH IN THE DEMAND FOR OUR PRODUCTS BY THE SLUGGISH ECONOMIES
ABROA~j THERE ARE TWO POSSIBLE REMEDIES FOR THE IMBALANCE IN OUR
TRADE ARISING FROM THIS SOURCE,

WE COULD SLOW DOWN OUR IMPORTS

BY SLOWING DOWN OUR ECONOMY, OR, WE COULD HOPE FOR ACCELERATION
OF OUR EXPORTS AS A BY-PRODUCT OF IMPROVEMENT IN ECONOMIC GROWTH
IN MAJOR INDUSTRIAL COUNTRIES ABROAD,
THE FIRST ALTERNATIVE WE CANNOT ACCEPT,

WE NEED MORE GROWTH,

NOT LESS, SO THAT WE CAN MAKE FURTHER INROADS ON UNACCEPTABLY
HIGH LEVELS OF UNEMPLOYMENT, AND SO THAT WE CAN CONTINUE TO


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Federal Reserve Bank of St. Louis

- 7PROVIDE STIMULUS TO ECONOMIC EXPANSION WORLDWIDE BY OUR OWN
ECONOMIC ADVANCES,

OBVIOUSLY, THE SECOND ALTERNATIVE IS PREFERABLE,

FROM OUR AS WELL AS THE WORLD'S VIEWPOINT,

WITH THIS IN MIND,

OUR GOVERNMENT HAS CONSISTENTLY USED INTERNATIONAL MEETINGS, SUCH
AS THE ECONOMIC SUMMIT OF THE HEADS OF MAJOR STATES LAST YEAR,
THE MINISTERIAL MEETINGS OF THE ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT, AND MANY OTHER FORMAL AND INFORMAL CHANNELS,
TO NUDGE OUR FRIENDS ABROAD INTO ECONOMIC EXPANSIONARY ACTIONS
ACTIONS THAT WOULD BENEFIT THEM IN REDUCING THEIR RECORD-HIGH
UNEMPLOYMENT, BENEFIT THE DEVELOPING COUNTRIES OF THE WORLD BY
PROVIDING FURTHER STIMULUS TO THEIR ECONOMIC GROWTH, AND BENEFIT
US BY IMPROVING MARKETS FOR OUR EXPORTS,

I HOPE OUR VOICES WILL

BE HEEDED--FOR OUR COMMON GOOD--AND THAT IN THE COMING YEAR, WE
SHALL SEE SOME IMPROVEMENT IN OUR TRADE ACCOUNT EMINATING FROM
-------~-----THIS SOURCE,

ff

. r-r;}

B:iNOTHER,1~~~~~,~G CAUSE OF OUR RAPID GROWTH IN IMPORTS--AND

OF OUR TRADE DEFICIT--HAS BEEN OUR VORACIOUS APPETITE FOR IMPORTED

$45 BILLION-UP FROM $36 BILLION IN 1976, AND UP FROM LESS THAN $5 BILLION AS
RECENTLY AS 1972, TRUE, SOME 80 PERCENT OF THE 1972-1977 INCREASE

OIL,

LAST YEAR, OUR OIL IMPORT BILL CAME TO ABOUT

IS ACCOUNTED FOR BY HIGHER PRICES RESULTING FROM THE ACTION BY

OPEC

1973. Bur BE THAT AS IT MAY, WE WERE STUCK WITH A $45
BILLION OIL BILL IN 1977. THIS IS A FORMIDABLE FIGURE--EVEN TO
IN

AN OLD

U.S.

BUDGET DIRECTOR LIKE MYSELF, THAT FIGURE HAS BECOME A

MILLSTONE AROUND THE NECK OF THE FLOATING DOLLAR!
WHAT CAN BE DONE?

IN

THE FINAL ANALYSIS, WE MUST TAKE OUR

OWN ENERGY BULL BY THE HORNS!


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Federal Reserve Bank of St. Louis

WE MAY RESENT THE CARTEL PRICING

n

- 0 -

POLICIES OF THE

OPEC.

WE MAY AGONIZE nvER THE DISRUPTION THAT

THE SUDDEN SHIFT IN PRICES OF ENERGY IS CAUSING TO OUR CHEAP
ENERGY-ORIE~TED ECONOMY AND OUR SOCIETY, WE CAN ARGUE, FOR A TIME
AT LEAST, OVER XHE ENVIRONMENTAL IMPACT OF INCREASED USE OF
ALTERNATIVE SOURCES OF ENERGY.

Bur

WE CANNOT CONTINUE TO LIVE IN

A FOOL'S PARADISE WHERE, FOR EXAMPLE, THE REAL PRICE OF GASOLINE
IS NOW ABOUT 16 PERCENT LOWER, AND NATURAL GAS GAS AND EL,ECTRICITY
IS SOME 4q PERCENT LOWER, THAN IT WAS SOME 30 YEARS AGO,

WE NEED

'

AN EFFECTIVE NATIONAL ENERGY POLICY SO THAT WE CAN MAKE DECISIVE
PROGRESS TOWARD DIMINISHING OUR RELIANCE ON IMPORTED ~0URCES OF
1

ENERGY,
HOWEVER, IN LOOKING AT OUR OIL-RELATED DEFICIT, WE MUST NOT
LOSE SIGHT OF CERTAIN STARK REALITIES,

OUR HEAVY RELIANCE ON OIL

AS THE MAJOR SOURCE OF ENERGY IS THE PRODUCT OF MANY, MANY YEARS
OF EVOLUTION, IT WILL TAKE MANY YEARS TO REVERSE THIS TREND,

IT

WILL TAKE MANY YEARS TO DEVELOP--AND INTEGRATE INTO OUR COMPLEX
ECONOMY--ALTERNATIVE SOURCE~ OF ENERGY,

THUS, WE CANNOT REALIS-

TICALLY EXPECT TO CUT BACK OUR OIL IMPORTS SIGNIFICANTLY IN THE
NEAR FUTURE,

NOR IS IT POSSIBLE IF THE "PRICE" WE MUST PAY IS A

--

SEVERE DISRUPT I ON IN OUR ECONOMIC GROWTH AND GREATER .UNEMPLOYMENT• ...e--~{
THERE IS ANOTHER DIMENSION TO THE OIL ISSUE AS IT RELATES TO
OUR TRADE DEFICIT,

lT IS THE MULTILATERAL NATURE OF OUR INTER-

NATIONAL TRADE--BOTH IN TERMS OF SPECIFIC COMMODITIES, AND IN
GEOGRAPHIC TERMS,

lN

OTHER WORDS, WE SHOULD NOT EXPECT TO BALANCE

OUR TRADE IN EVERY COMMODITY OR WITH EACH OF OUR TRADING PARTNERS!

foR EXAMPLE, OF THE TOTAL $45 BILLION OIL-IMPORT BILL INCURRED
LAST YEAR, $34 BILLION REPRESENTED OUR BILATERAL IMPORTS FROM THE

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Federal Reserve Bank of St. Louis

... 9 -

OPEC

COUNTRIES (THE REST WAS LARGELY FROM CANADA AND ~EXICO),

THIS

$34 BILLION WAS PARTIALLY OFFSET BY OUR $14 BILLION SURPLUS

OF NON-OIL EXPORTS TO THEM,

IT IS THE BASIC PROPOSITION ON WHICH

AU.. lf-.TERNATIONAL TRADE IS PREDICATED THAT EACH COUNTRY SPECIALIZES
IN THE PRODUCTION AND EXPORT OF THOSE COMMODITIES IN WHICH IT HAS
A COMPARATIVE ECONOMIC ADVANTAGE,

FURTHERMORE, IT IS IN THE VERY

iiATURE OF THE WORLD'S MULTILATERAL TRADE RELATIONSHIP THAT EACH
COUNTRY'S DEFICIT IN TRADE WITH THE UNITED STATES IS OFTEN MERELY
A COUNTERPART OF ITS SURPLUS WITH ANOTHER AREA OR AREAS,
VEIN, OUR BILATERAL DEFICIT IN OIL TRADE WITH THE

OPEC

IN THAT

NATIONS

MAY BE VIEWED AS BEING TO SOME DEGREE COVERED BY OUR BILATERAL
TRADE SURPLUS WITH THE EUROPEAN ECONOMIC COMMODITY NATIONS WHO,
IN TURN, ARE SELLING THEIR GOODS TO THE

OPEC

COUNTRIES,

IN THE

FINAL ANALYSIS, A VIABLE TRADE OF ANY COUNTRY IS PREDICATED ON
THE COMPETITIVENESS OF ITS GOODS ON THE WORLD MARKETS!

Arm THIS BRINGS ME TO YET ANOTHER UNDERLYING CAUSE OF OUR
DEFICIT--THE COMPETITIVENESS OF

U.S.

GOODS ON THE WORLD MARKETS,

COMPETITIVENESS OF ANY COUNTRY'S GOODS ON THE WORLD MARKETS IS
GENERALLY DETERMINED BY THE QUALITY OF ITS PRODUCTS, DELIVERY
PROMPTNESS, AND FOLLOW-UP SERVICES--BUT ABOVE ALL, IT IS DETERMINED
BY THE PRICES OF ITS PRODUCTS,

THE FINAL PRICES OF A COUNTRY'S

PRODUCTS ON THE WORLD MARKETS ARE DETERMINED THROUGH A TWO-TIER
PROCESS, THE FIRST TIER RELATES TO THE RATE OF PRICE CHANGES--THE
RATE OF INFLATION--WHICH DETERMINES THE PRICES OF THE COUNTRY'S
GOODS IN I TS mm CURRENCY

I

NEXT, IT Is THE MOVEMENT OF EXCHANGE

RATES THROUGH WHICH SPECIFIC DOMESTIC PRICES ARE uTRANSLATEDn


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Federal Reserve Bank of St. Louis

- 10 INTO SPECIFIC INTERNATIONAL PRICES,

THIS CONSTITUTES THE SECOND

TIER THROUGH WHICH INTERNATIONAL COMPETITIVENESS IS BEING DETERMINED,
LET'S TAKE A LOOK AT THE SITUATION AS IT HAS UNFOLDED DURING
THE PAST SEVERAL YEARS,

ON

THE ''FIRST TIER," THE DOMESTIC WHOLESALE

PRICES OF MANUFACTURED GOODS -(PRICES GENERALLY MOST RELEVANT IN
INTERNATIONAL TRADE) ROSE BY ALMOST

7 PERCENT

IN THE UNITED

3 PERCENT, IN JAPAN BY 2 PERCENT, AND IN
SWITZERLAND THEY ACTUALLY DECLINED BY ALMOST 1 PERCENT BETWEEN
STATES, IN GERMANY BY

THE Erm OF' 197C AND LATE 1977.

OBVIOUSLY, OUR COMPETITIVE POSITION

AGAINST THESE COUNTRIES IN TERMS OF DOMESTIC PRICES ERODED DURING
THE YEAR,
HOWEVER, THE MOVEMENTS IN THE EXCHANGE RATES OF THESE CURRENCIES
RELATIVE TO THE DOLLAR--THE SECOND-TIER PROCESS--MAY EE VIEWED AS
COMPENSATING FOR THE TRENDS

o_

N TH~

;p IRST

-tl.t_ d!.e--~

~ {..,(/ ~

THE EXCHANGE RATE CHANGES~ A 69UPITIW WITH11I"FS

Tfilc&ifli iM,iiTWiR~

GiHQ6i811t8 b?dtADsO.)

J~ ~_WEIGHT

TI ER."

J:4

_/
"'~,;,~ tJ

MOS'f IMPORTI\iN'I"

BY THE VOLUME OF THE TRADE,

AND ADJUST THESE FOR THE DOMESTIC RATE OF INFLATION IN THESE
COUNTRIE~

/4

~

COME TO A CONCLUSION THAT MAY BE SURPRISING TO

ALTHOUGH THE DOLLAR DEPRECIATED BY ABOUT 10 PERCENT IN -li/7· -

MANY,

5e-

AGAINST THE CURRENCIES OE
AHB ~3

P11\J0R

lut'!o PEAtl

A

~RQtJP OF HAT I OHS

&QUM+R I ca

AT

I HE £ND OP

TMA+ H~CbUQED dAll~N

1~77, THE U. S.

COMPETITIVE POSITION (AS DETERMINED BY THE "TWO-TIERn PROCESS) IN
RESPECT TO ITS

d tk

14

M,«J ;;(

MAJOR TRADING PARTNERS WAS ALMOST PRECISELY THE

1911

SAME~AS IT WAs-'IN 1973!

To SUM UP, OUR CURRENT DEFICIT MAY HAVE BEEN CAUSED AT LEAST
IN PART BY OUR RELATIVE LOSS OF COMPETITIVENESS DURING THE EARLIER


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Federal Reserve Bank of St. Louis

1
t

- 11 PART OF TH[

1973-77

PERIOD.

Bur

THE MOVEMENTS IN THE EXCHANGE

RATE OF THE DOLLAR RELATIVE TO MAJOR CURRENCIES HAVE TENDED TO
REESTABLISH THAT COMPETITIVENESS ALBEIT ON A LAGGED BASIS,

So

MUCH FOR THE PROBLEMS OF THE DECLINING DOLLAR AS THEY

RELATE TO THE DEVELOPMENTS IN OUR TRADE ACCOUNT,

LET ME

NO\·!

TURN

TO THE MONEY AND CAPITAL MARKETS,
DATA ON THE SUPPLY AND DEMAND FOR DOLLARS ON THE FOREIGN
EXCHANGE MARKETS ARISING FROM MONEY AND CAPITAL TRANSACTIONS
BETWEEN TliE UNITED STATES AND COUNTRIES ABROAD ARE AVAILABLE ONLY
THROUGH SEPTEMBER OF

1']77,

THEY INDICATE THAT THE DEMAND FOR

DOLLARS IN THE CAPITAL ACCOUNT AMOUNTED TO ABOUT $29 BILLION,
WHILE THE SUPPLY OF DOLLARS (ARISING FROM ACQUISITION OF FOREIGN
ASSETS AND INVESTMENTS BY
DILLION,

U.S.

RESIDENTS) CAME TO ABOUT

$13

THIS, ON THE SURFACE, WOULD APPEAR TO BE A RATHER

"FAVORABLE" CONSTELLATION OF THE SUPPLY AND DEMAND FORCES,
HOWEVER, A CLOSER LOOK AT THE FIGURES INDICATES THAT THREEQUARTERS OF THAT OBSERVED "DEMAND" FOR DOLLARS WAS ACTUALLY A
"RESIDUAL DEMAND,"

THAT IS, IT REPRESENTED ACQUISITION OF DOLLARS

BY FOREIGN OFFICIAL INSTITUTIONS AS THEY INTERVENED IN THE
FOREIGN EXCHANGE MARKETS IN THEIR EFFORTS TO MODERATE THE RISE OF
THEIR CURRENCIES RELATIVE TO THE DOLLAR!

PRIVATE FOREIGN DEMAND

FOR DOLLARS APPEARED TO HAVE FALLEN QUITE SHORT OF SUPPLY IN THE
MONEY AND CAPITAL TRANSACTIONS, PARTICULARLY IN THE LAST FEW
MONTHS OF THE YEAR,

IN PART, THE CAUSES OF THIS TREND WERE "ECONOMIC" IN ORIGIN;
IN PART, THEY WERE A REFLECTION OF PREVAILING MARKET PSYCHOLOGY,
ON THE ECONOMIC SIDE, THE TREND REFLECTED CONTINUED THE EXCESS OF


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Federal Reserve Bank of St. Louis

- 12 OUR CORPORATE LONG-TERM INVESTMENT ABROAD OVER FOREIGN INVESTMENTS
IN THE UNITED STATES--DESPITE ALL THE TALK WE HEAR ABOUT FOREIGNERS

TAKING OVER OUR FARMS, OUR BANKS, AND OUR FACTORIES,

IT ALSO

REFLECTED THE ACTIVITIES OF U,S, BANKS AND OTHERS IN ACCOMMODATING
DEMAND FOR CREDIT AROUND THE WORLD IN THE FORM OF LOANS AND
PURCHASES OF FOREIGN SECURITIES,
\JHAT CAN BE DONE ABOUT THESE FLOWS AS A MEANS OF IMPROVING
THE TRENDS IN THE VALUE OF THE DOLLAR? FoR THE BENEFIT OF THOSE
OF YOU IN Tl-IE AUDIENCE WHO STILL LIVE ~!ITH THE PAINFUL MEMORIES
OF THE "VOLUNTARY FoREIGfJ CREDIT RESTRAINT PROGRAM," THE "INTEREST [OUALIZATION TAX," THE "FOREIGN DIRECT INVESTMENT PROGRAM,"
AND OTHER PROGRAMS INSTITUTED TO SHORE UP THE DOLLAR IN THE
SIXTIES, LET ME STATE CATEGORICALLY THAT

I AM NOT AWARE OF ANYONE

I1~ THE U.S. GOVERNMENT WHO IS PRESENTLY ADVOCATING OR CONTEMPLATING ARTIFICIAL SUPPORT OF THE DOLLAR BY IMPOSING RESTRICTIONS
ON THE FLOW OF CAPITAL TO OR FROM THIS COUNTRY:
TODAY RECOGNIZES THE VITAL ROLE

U.S.

BANKS,

U.S.

l THINK EVERYONE
INDUSTRY, AND

U,S, INVESTORS PLAY AS INTERMEDIARIES OF INTERNATIONAL FINANCIAL
FLOWS, AND AS SUPPLIERS OF SORELY NEEDED CAPITAL TO THE ECONOMIES
OF THE WORLD'S FREE NATIONS--DEVELOPED AS WELL AS DEVELOPING,
[10REOVER, ANY RESTRICTIONS ON PRODUCTIVE CAPITAL FLOWS ARE
UNNECESSARY WHEN IT IS RECOGNIZED THAT IT WAS LARGELY THE PRESENCE
OF ADVERSE "PSYCHOLOGICAL" FACTORS IN THE MARKET THAT HAVE BEEN
CAUSING THE RECENT ADVERSE DEVELOPMENTS IN THE INTERNATIONAL
MONEY AND CAPITAL ACCOUNTS,

AVAILABLE DATA SUGGEST THAT IT WAS

THE HUGE SHIFTS OF SHORT-TERM FUNDS, AT TIMES SPECULATIVE IN
NATURE, THAT AGGRAVATED THE DOWNWARD PRESSURE ON THE DOLLAR IN


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- 13 THE FORE I GiJ EXCHANGE MARKETS,
THE

IMPETUS TO~~ARD REVERSING THE ADVERSE CAPITAL FLOWS

AFFECTING THE DOLLAR MUST COME FROM IMPROVEMEflTS IN THE "PSYCHOLOGY"
OF THE INTERNATIONAL FINANCIAL MARKETS,

'!E HAVE TO RESTORE THE

APPARENTLY SHAKE~ CONFIDENCE OF FOREIGN INVESTORS--AS WELL AS

~.S.

INVESTORS--IN OUR ABILITY TO REDUCE INFLATIONARY DANGERS AND

TO MANAGE OUR AFFAIRS IN A WAY CONSISTEtJT WITH OUR LEADERSHIP
POSITION IN THE WORLD ECONOMY.
TiiERE ARE, OBVIOUSLY, MANY ELEMENTS THAT GO INTO WEAVING
THIS FABRIC OF nMARKET PSYCHOLOGY," AND IT WOULD BE PRESUMPTUOUS
OF Mi: TO TRY TO UNRAVEL THEM IN THE TIME REMAINING,

LET ME JUST

MENTION A FEW AREAS WHERE POSITIVE ACTION, IN MY JUDGMENT, CAN GO
A LOiW

WAY,

i·~E MUST ALL GIVE OUR SUPPORT TO OUR GOVERNMENT

TOWARD RESOLVING NATIONAL POLICY UNCERTAINTIES, SUCH AS OUR
ENERGY AND TAX POLICIES, WE MUST DEMONSTRATE TO THE REST OF THE
~WRW OUR RESOLVE TO FORMULATE RESPONSIBLE ECONOMIC POLICIES IN
RESPECT TO INFLATION AND LONG-TERM ECONOMIC GROWTH,
IN THESE AREAS WILL,

I

IMPROVEMENTS

BELIEVE, CONTRIBUTE SIGNIFICANTLY TO AN

IMPROVEMENT IN MARKET PSYCHOLOGY, AND THUS TO IMPROVEMENT IN THE

POSITION OF THE DOLLAR INTERNATIONALLY,

IN TRYING TO ANSWER THE QUESTION, "WHAT

U.S.

DOLLAR?n

I

IS

HAPPENING TO THE

FOCUSED ON A NUMBER OF FACTORS THAT, IN MY

JUDGME,ff, HAVE PLAYED AN IMPORTANT ROLE IN THE RECENT DEVELOPMENTS,
TtiEY WERE WHAT

l

WOULD CALL FUNDAMENTAL ECONOMIC FACTORS, THE

RESULTS OF COMPLEX ECONOMIC INTERACTIONS WITHIN OUR ECONOMY, AND
OF THE INTERACTION OF OUR ECONOMY WITH THE REST OF THE WORLD--THAT
SUBMERGED PART OF THE ICEBERG THAT


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I REFERRED TO EARLIER. THERE

IS MO EASY ANSWER--AND NO EASY SOLUTION--TO ~mAT HAS BEEN HAPPENING
TO THE U (' DOLLAR, l\N IMPROVEMENT IN THE POSIT ION OF THE
101

u

Is I

DOLLAR WILL REQUIRE SYSTEMATIC PROGRESS ON MANY FRONTS, WE ARE ON
THE RIGHT ROAD,

OUR ACTIONS AND OUR ECONOMIC POLICIES /\RE EVOLVING

HITH THE INTEGRITY OF THC DOLLAR IN MIND,

WE ARE NOT PRACTICING

A POLICY OF "BENIGN NEGLECT" IN RESPECT TO THE DOLLAR AS SOME OF
OUR FR 1ENDS ABROAD HAVE ACCUSED US JUST BECAUSE NE

!➔ AVE

INTERVENED MORE HEAVILY IN THE FOREIGN EXCHANGE MARKETS!

NOT
OUR

POLICY OF LIMITED OFFICIAL INTERVENTION HAS PROVED TO EE VERY
CONSTRUCTIVE THUS l=AR, PARTICULARLY AS IT HAS TENDED TO THROW
SPECULATORS OFF GUARD,

INTERVENTION IS A MANAGEMENT STRATEGY,

ALBEIT A VERY VALUABLE ONE: IT IS NOT A CURE,

IN BROAD PERSPECTIVE, OUR POLICIES IN RESPECT TO THE DOLLAR
MUST BE GU I DED BY TWO BROAD PR I MC I PLES,

Or!E

SUCH PRINCIPLE

DERIVES FRot1 OUR EXISTENCE AS A VIABLE MEMBER OF THE TRADING
COMMUNITY OF NATIONS,

THAT VIABILITY IS LARGELY PREDICATED ON

OUR ABILITY TO rlAINTAIN A HEALTHY, NONINFLATIONARY ECONOMY, AND
ON OUR ABILITY "TO PAY OUR WAY"--TO SEE TO IT THAT OUR INTERNATIONAL ACCOUNTS ARE KEPT IN A REASONABLE BALANCE,

~O NATION,

JUST LIKE NO INDIVIDUAL, CAN GO ON SPENDING FOREVER MORE THAN IT
EARNS:

THE

OTHER PRINCIPLE COMPRISES CONSIDERATIONS HJVOLVING

THE VIABILITY OF THE ENTIRE WORLD TRADING SYSTEM,

THAT VIABILITY

IS PREDICATED ON THE PROPOSITION THAT ALL TRADING NATIONS MUST
SACRIFICE CERTAIN SELF-SERVING OBJECTIVES FOR THE BENEFITS THEY
DERIVE FROM A FREE INTERNATIONAL EXCHANGE OF GOODS,

No NATION

CAN EXPECT TO BUILD ECONOMIC BENEFITS FOR ITSELF BY HEAPING
ADVERSITIES ON OTHERS,


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- 15 -

As

LONG AS WE, AS WELL AS OTHER NATIONS, ADHERE TO THESE

PRINCIPLES OF NATIONAL AND INTERNATIONAL RESPONSIBILITY, I AM
CONVINCED THAT THE FUTURE OF THE DOLLAR WILL BE SECURE,


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