By George P. Brockway, originally published February 8, 1988
I SEE BY the papers that many a pundit, from the President on down, thinks the dollar should fall a bit more-but not too much more. How much is too much? Two answers are given: (1) We don’t want to scare foreign investors into pulling their marks .and yen out of our economy, and/or (2) we don’t want to do anything to start inflation again. Quick rejoinders are: (1) There are dollars but no marks and yen in our economy, and (2) no one who has had occasion to buy anything thinks inflation has ever stopped. Let’s take a look at the problem in a little more detail.
Those foreign investors were a big concern of former Federal Reserve Board Chairman Paul A. Volcker (see “Vale, Volcker,” NL, June 1-15, 1987). The story was that we needed them to finance the budget deficit because, as pundits keep telling us, we don’t save enough to finance it ourselves. And the foreigners, being strangers in a strange land, had to be offered bait in the form of high interest rates. It is possible to argue that our maneuver was self-defeating, since the annual interest on the Federal debt is now close to double the annual deficit. Yet mistake or not, the bonds have been sold, some with coupons as high as 15.75 per cent, and there is nothing that can be done about it; so we should (as the President plaintively pleads about a great many things) put it behind us.
At this point we are supposed to worry that foreigners will pull out if the dollar falls much lower, and it is certainly understandable that the Great Crash of 1987 may have made them skittish. Getting their money out could, however, be a bit more complicated than it appears.
Say Mr. Togo has some of those nice 15.75 per cent 20-year bonds (payable November 15, 2001) and so does Ms. Falck, and they want to sell them. No problem. The quote this morning is 153 bid, 153 6/32 asked. Although the price may shift a bit one way or the other by the time our foreign friends contact a bank or a broker, they can be confident of selling the bonds at 153, give or take a few cents. Cents? Well, yes, and naturally the 153 is dollars. They’ll get $15,300 for each $10,000 bond they own – a nice capital gain on top of the 15.75 per cent interest they’ve been receiving since purchasing the bonds in 1981.
But Mr. Togo and Ms. Falck don’t want dollars and cents. The whole idea is to pull their money out of the United States, because the financial tipsters they read tell them Washington isn’t going to put its house in order (whatever that means). They want good old yen and marks, respectively. Again, no problem. This morning the yen is quoted at 127.90 to the dollar, and the West German mark at 1.6805 to the dollar. There may be a slight fluctuation before the exchange is made; still, Mr. Togo and Ms. Falck will have their familiar currency back.
Now, when Mr. Togo and Ms. Falck are given yen and marks for their dollars, it is because someone buys their dollars for yen and marks. Obviously. But look you: The numbers of dollars, yen and marks remain the same (this is one place where money has a quantity). Mr. Togo and Ms. Falck can get their money out only if some other foreigners put theirs in.
Should all foreigners try to get their money out simultaneously, the exchange rate of the dollar would surely fall, and fall very fast (this is the one place where the law of supply and demand works). It wouldn’t be a free fall. At some stage Mr. Togo’s compatriots would get so few yen for their dollars that, say, $40 million wouldn’t be worth much to them, and they might just as well use it to buy a painting of flowers that van Gogh never got around to finishing. Or Ms. Falck’s compatriots might think it smart to buy an American publishing house or two with their cheap dollars.
In the end, the only way all foreigners can get their money out of the States is by buying something we have to sell. Of course, this is how they got the dollars in the first place: We bought some of what they had to sell. It is also well to remember that, budget deficit and all, ours is a pretty stable society and therefore not altogether a bad place to keep your money. Moreover, our debts are denominated in dollars (except for some worrisome ventures of our biggest borrowers), which distinguishes us from Third World debtors (see “Becoming a Debtor Nation,” NL, February 24, 1986).
The pressure is not all one-sided. We’re eager to buy Hondas and BMW’ s, and they’re eager to buy American securities, both public and private. They may not be so eager to buy more securities if the Federal Reserve lets the dollar continue to fall, but they’ll have to buy something we have to sell-unless they intend to give us Hondas and BMW’s for free.
They may buy goods we produce, and that will certainly be fine with us. On the other hand, they may buy or build factories to make a Stateside version of the Honda. Or they may put their excess dollars into real estate. Large chunks of our major cities are already Japanese owned, just as large chunks of London are Arab owned (and substantial pieces of Manhattan are British and Canadian owned). Patriotic sentiment aside, should we be upset by foreign investment in American industry and real estate?
From the standpoint of American working men and women, it makes no difference who their employers are (unless they’re self-employed) so long as the employers are fair and decent. From the standpoint of American consumers, it makes no difference who produces the merchandise they buy so long as the quality is good and the price is fair. From the standpoint of American investors- well, they’ve shown themselves more interested in speculating on the stock market, anyhow. From the standpoint of the American government, taxes on foreign-owned income could be as good as taxes on domestic-owned income (I say “could be” because the Administration has wimpishly restored breaks for foreigners that we’ve canceled for ourselves).
There remains the problem of the profits earned by these foreign-owned factories and buildings. Our payments to foreigners are already in the tens of billions of dollars annually. If they go even higher, won’t they drain the lifeblood out of the economy? Hardly. These profits are in dollars and thus only exacerbate the foreigners’ difficulty in converting dollars to yen or marks or whatever. The profits will have to be spent on American goods or invested in American industries or exchanged for yen or marks at increasingly unattractive rates.
Mr. Togo’s and Ms. Falck’s last option is worth a moment’s notice. It is their ultimate option; and if the dollar continues to fall, it won’t be worth much. In an unexpected way it will fulfill Keynes‘ prophecy of the “euthanasia of the functionless investor.” As Keynes explained in the closing chapter of The General Theory:
“Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital.”
Unfortunately for Mr. Togo and Ms. Falck, capital denominated in dollars is overabundant and will accordingly be ill paid. (It happens to be overabundant in their homelands, too, but that’s not our worry.) Of course, Mr. Togo and Ms. Falck still have the penultimate option of leaving their money where it is, in which case there is no need for the Federal Reserve Board to “defend the dollar.”
BECAUSE DOLLARS will mean so little to them, our Japanese and German friends will be increasingly able to outbid us for paintings and publishing houses and such that come on the market. That will be a blessing for those of us who have things for sale, but it brings us to the second problem of the falling dollar-inflation.
Conventionally, this is seen to result from the rising dollar cost of imports. The effects are both direct and indirect. Directly, to the extent that the price of a Mercedes is a factor in the Consumer Price Index, an increase in the number of dollars it takes to buy a Mercedes tends to increase the CPI. Indirectly, if it becomes necessary to put up $85,000 worth of marks to import a Mercedes, General Motors might feel safe in bumping the price of a Seville to $75,000. There is little in the history of General Motors to suggest a reluctance to do the bumping, nor can I think of any likely reason for them to hang back.
Potentially more serious are increases in the costs of raw materials, principally oil. The effect here is somewhat mitigated by the fact that OPEC quotes its prices in dollars. It is also mitigated by the fact that sluggish economies around the world have made oil a glut on the market. It could be further mitigated, if not eliminated, by the pursuit of rational conservation policies-but that’s probably too much to expect us to undertake.
The inflationary effect I call your attention to is the bidding up of the prices of American industries. That happens when companies are bought outright and also when shares are bought on the exchanges. The Great Crash of 1987 is one sort of consequence. A much more dangerous consequence is the compulsive reaction of American managements to increased valuation of their companies. They feel obligated-and indeed are obligated by their investment bankers- to try to raise profits to match the increased valuations. They can do this in two ways, neither of them desirable -by raising prices, which is inflationary, and by holding down wages, which is stagnatory.
In the space remaining I can only suggest that the conventional solution of protecting the dollar by raising interest rates is precisely wrong-headed: It is merely another prescription for stagflation. The hopeful solution would combine a monetary policy of low interest rates (that would tend to encourage industry) with a fiscal policy of steeply progressive taxation (that would tend to discourage speculation by foreigners as well as by Americans).
If such a solution incidentally soaked the rich, it’s about time, for it must be acknowledged that they have not performed faithfully as stewards of the inordinate share of the common wealth they have engrossed over the past 15 years, and especially over the past seven. Their wanton misuse of their increased riches mainly to create a bull market and a crash was, and is, a passionless prodigality.
The New Leader
 As far as the editor can determine the names Togo and Falck are intended to represent generic Japanese and German investors and do not refer to actual individuals.
 Editor’s note, the author had been chairman of “an American publishing house,” at the time, and now, still privately held by the employees