A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Büschgen, Hans E. Article — Digitized Version The US dollar- scenario of a world currency Intereconomics Suggested Citation: Büschgen, Hans E. (1987) : The US dollar- scenario of a world currency, Intereconomics, ISSN 0020-5346, Verlag Weltarchiv, Hamburg, Vol. 22, Iss. 2, pp. 59-68, http://dx.doi.org/10.1007/BF02932274 This Version is available at: http://hdl.handle.net/10419/140066 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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What part was played by the adverse "fundamentals" of the US economy, the large current account deficit, the country's heavy foreign indebtedness and the substantial budget deficit? How will the dollar behave in future? n analysis of the behaviour of the US dollar is stability until 1969, when there began a series of dollar A ,particularly interesting, since it is assumed that the devaluations culminating in the transition to floating dollar exchange rate reflects significant changes in exchange rates in place of the system of fixed but global economic relationships while at the same time adjustable rates. The dollar was weak for many years having a decisive influence on the economic after the decision to float, reaching a low of DM 1.7358 expectations and decisions of firms and individuals on 25th July 1980. The subsequent appreciation took it throughout the world, and hence on world economic to a peak of DM 3.4690 on 26th February 1985; since developments. The key role of the dollar exchange rate then, the exchange rate has slipped back to well below stems from the pre-eminent position of the USA in the DM2. world economy and its virtual hegemony over the western industrialised countries. An awareness of this Throughout this period there were frequent and heated debates about the "right" exchange rate for the role is clearly discernible in the utterances and dollar and attempts to achieve what was considered a behaviour of representatives of the US Administration in correct target rate by means of government action or recent months, particularly Treasury Secretary Baker. central-bank intervention in the foreign exchange The dollar's important role in the global network of markets; sometimes they were successful, but most of relationships is also clear from its functions in the world the time they were not. Depending on one's standpoint, economy. The dollar is a transaction currency; the bulk a given rate was reckoned to be too high or too low and of world trade in goods and services is invoiced in the dollar to be overvalued or undervalued, which meant dollars and the dollar is often used as a "vehicle that countries and economic interests with different currency" in the foreign exchange markets. It is also a objectives could take a different view of the same reserve currency, held by the central banks of the world. exchange rate. Both high and low dollar rates were Thirdly, it serves as a key currency; numerous countries regarded as possible causes of impending disaster in have tied the parity of their currencies to the dollar. the economic and monetary system. Finally, it is the premier currency for borrowing and lending in the international financial markets, even if the The discussions between the economic policymakers share of Euro-currency transactions in non-dollar of the USA, the Federal Republic of Germany and Japan currencies has risen to around 50 % recently on account in recent months, and especially in advance of the last of the weakness of the dollar. Annual Meeting of the International Monetary Fund, provide a prime example of differences in assessing the Chronicling the exchange rate of the dollar against the behaviour of the dollar; whereas the Deutsche Deutsche Mark from Bretton Woods in 1944 to the Bundesbank, the Federal German Government and the present day shows that there was a long period of Japanese Government considered a dollar exchange rate of around DM 2 to be low enough, the US * University of Cologne. The article is a revised version of a lecture Administration wanted the dollar to depreciate still delivered at a seminar held by Honeywell Bull AG, Cologne, on 18th November 1986. further. The Americans are not of one accord, however; INTERECONOMICS, March/April 1987 59 MONETARY POLICY Paul Volcker, the Chairman of the Federal Reserve as important fundamentals was that "a strong country Board, fears the risk of inflation if the dollar continues to has a strong currency". The USA was therefore seen as slide, while James Baker, the Treasury Secretary, the "safe haven" in which the monetary wealth of the advocates a cheaper dollar as the means of restoring world took refuge. American competitiveness. In fact, the true reasons are far more prosaic. With the The change in the US Administration's attitude Federal Reserve pursuing a restrictive monetary policy, towards the external value of its own currency, as US interest rates were pushed up by the steady rise in expressed in the so-called Plaza Agreement of 1985 government debt and the associated demand for among the representatives of the five leading capital; interest rate differentials in favour of the United industrialised countries (the Group of Five), is a new States triggered the substantial inflow of capital into the element in the monetary equation. The sudden USA and the sharp reduction in capital outflows. The willingness of the US Administration to heed and to negative "fundamentals" were therefore largely offset influence the dollar exchange rate followed a long by the massive capital inflows, in other words the period of almost complete indifference. Ronald Reagan increasing indebtedness of the USA towards the rest of had raised the dollar question in the election campaign the world. It was not primarily the acquisition of equities against President Carter, but primarily for electoral and or direct investments in view of the supposedly superior nationalistic reasons. He was elected partly because he earning power of US business, as was often argued, but promised an economic programme in which the dollar simply interest-rate-induced capital movements that would again become a stable currency held in high financed the US current account deficit. In other words, regard throughout the world, after having steadily the capital inflows into the USA that kept the dollar depreciated to DM 1.73 in 1980 as a result of a loss of strong can be explained satisfactorily in terms of the confidence caused by years of massive capital positive interest rate differential and the scant heed that movements. was initially paid to exchange rate risks. In February 1985, however, the dollar stood at almost Reaganomics and the Dollar Exchange Rate DM 3.50, a level that forced foreign investors to pay At first, Reagan's economic policy produced good urgent heed to the exchange risks, alerted businesses results for a number of macro-economic objectives; in the USA to the economic consequences of the high growth, employment and inflation rate improved dollar exchange rate and aroused the Administration considerably. However, what was not noticed in the from its long indifference towards the macro-economic initial euphoria about "Reaganomics" was that success implications of a strong dollar. The growing dollar on these fronts was accompanied by an extraordinary balances held by foreign investors, in other words the deterioration in public finance and in the balance of United States' external debt, reached such proportions payments; the results of Reaganomics were achieved at in 1985-86 that they began to be perceived by investors the price of an exorbitant indebtedness. Reducing taxes as a problem from the point of view of yield and risk. without cutting government expenditure in the hope that Combined with the negative fundamentals of the economic growth would generate the needed higher government debt, the external debt and the current revenue - the so-called Laffer curve - did not pay off. account deficit, this caused the dollar to depreciate in Ardent adherents of Reaganomics, who were at the the autumn of 1985, despite the continued favourable same time speaking disparagingly of "Eurosclerosis" interest rate differential. with regard to the economy of Europe, overlooked the The fall in the dollar exchange rate induced by fact that the unbridled expansion in US government debt economic factors was reinforced by the concerted and the rapidly growing current account deficit in the intervention agreed in September 1985 by the "Big Five" USA were creating a highly dangerous situation that has (Plaza Agreement) which was based expressly on the developed a momentum of its own and now threatens premise that the exchange rate of the dollar against the not just the USA but the whole world economy.