For the first time since the remarkable recovery of the U.S. dollar triggered by President Carter's dramatic rescue program last Nov. 1, sophisticated international monetary circles are asking if the dollar has become too strong.
It is a sensitive subject. Exchange-rate relationships among the major currencies sometimes work in strange ways. Last year, Treasury Secretary W. Michael Blumenthal earned the opprobrium of financial market people by appearing to "talk the dollar down."
By suggesting publicly that he was prepared to accept a depreciation of the dollar, if that's the way exchange markets saw it, Blumenthal unintentionally promoted the idea that the dollar was overvalued. Many financial market people bluntly blame him for helping precipitate the 1978 dollar collapse.
Now, with the recovery having recouped only about half the real effective dollar depreciation between September 1977 and October 1978, no one is ready to suggest that the dollar needs any "talking down."
Government policy is that the present situation of the dollar is just about right. According to authoritative sources, there is no intention of pursuing a steady strengthening of the dollar above present levels.
Nor does anyone-least of all the main U.S. tradeing partners-seek to undermine the remarkable stability of the dollar since last November. Despite the introduction of the European Monetary System early this year to generate "a zone of stability," the world still essentially depends on a steady course for the American greenback.
A European monetary official put it this way: "The EMS was constructed because the dollar was weak or unstable. At the same time, we Europeans realize the EMS scheme cannot function unless the dollar is stable and not weakening. Everyone is interested in the U.S. having a relatively stable dollar."
Nonetheless, a combination of economic forces-many of them unseen at the time the Nov. 1 "rescue" program was launched-weakened other currencies at the same time the dollar was recovering.
After Nov. 1, what some characterized as a "free-fall slide" of the dollar was reversed by Carter's commitment to an austerity program. The support package featured a sharp boost in interest rates, a promise to work for effective control of inflation and a massive dollar intervention program to prop up the price in the world's exchange markets.
Even more important, there was a perception that the president meant business. It was not lost on sharp-eyed money traders that the basic announcement of a higher interest-rate policy-set in motion for international rather than domestic reasons-was made in an unprecedented joint release by the White House and the Federal Reserve. Moreover, there was reason to believe that the White House, spurred by Blumenthal, actually had initiated the policy.
To the rest of the world, this spelled the end of a policy of benign neglect. With the U.S. joined by West Germany, Japan and Switzerland in an open-ended, multi-billion-dollar accumulation of resources for intervention, the markets were faced for the first time with "a greater sense of two-way risk," as Treasury Undersecretary Anthony Solomon pointed out.
Although some worried that the $30 billion worth of resources marshalled for intervention by the U.S. wouldn't be enough, it proved necessary to use only a fraction of that amount. Currencies borrowed from other countries largely have been paid back, and total resources on hand for intervention are larger than they were at the beginning of the year. As the dollar held up, many speculators-and multinational companies-took a bad beating.
In the first quarter of 1979, there was a net inflow of $16 billion of private capital, just about reversing the net outflow in the last quarter of 1978. And the dollar would have been even stronger- and the yen, mark and Swiss franc weaker-had it not been for heavy intervention by the central banks of those countries to stop the slide in their own currencies.
The framers of the Nov. 1 rescue package admit that in their wildest dreams they didn't visualize such a scenario.
Now the Nov. 1 package-initially greeted with a degree of skepticism-is universally hailed as a spectacular success. The dollar has appreciated about 9 percent against the West German mark. Against the Swiss franc, the gain is about 15 percent. Against the Japanese yen, the gain is more than 20 percent. Only the British pound, supported by oil gushing from the North Sea, has outperformed the dollar in this period.
Blumenthal is fond of saying that "appearance is as important as reality" in all areas of policy-making. Many observers think that the Nov. 1 package struck the right balance of "doing things right, as well as appearing to do them right." The program had the necessary elements, was crisply explained, was well-executed in the markets, and began to take effect precisely as the staggering deficits in the U.S. trade and current accounts (services plus trade) came down-largely because the depreciated dollar helped to restore a competitive advantage to U.S. products.
But then a new and significant economic fact emerged: Inflation began to boil over again in Western Europe and Japan, exacerbated by oil shortages and price increases that followed revolution in Iran.
As Florence Alberts, Bank of America economist points out, Middle East oil represents 30 percent of Japan's total oil import bill, but only 20 percent of the U.S. oil import bill. The Organization of Petroleum Exporting Countries' price increases since the first of the year have stung harder across Europe than in the U.S. In Germany- famed for tiny inflation rates-the annualized first-quarter cost-of-living increase was a shocking 8.5 percent (although German officials anxiously note that there are some sesonal distortions in that figure, and still predict a 1979 inflation rate under 4 percent).
The effect on exchange rates has been most dramatic in the case of Japan, where the yen appreciated to a peak of about 186 to the dollar just before the Nov. 1 package. As the dollar strengthened, the yen weakened, then seemed to stabilize around 200 to the dollar.
But as the exchange markets assessed the impact of rising oil prices on the Japanese economy-and the prospect that Japan's enormous 1978 worldwide current account surplus might drop from $20 billion to about $8 billion-there was a speculative selling burst against the yen. A concerted drive against Japanese imports, especially by the Common Market, seems to be taking hold.
In some ways, speculation against the yen reflected a similar market overreaction to the one that swamped the dollar last October. The yen quickly was driven down to about 225 to the dollar at the end of April. Since then, in response to a statement here May 3 by Prime Minister Masayoshi Ohira that the Bank of Japan would intervene heavily in an attempt to return to a 200-to-1 ratio, the yen has appreciated from 225 to 1 to about 215 to 1.
The only American official to speak out publicly on the recent dollar-yen relationships has been Federal Reserve Chairman G. William Miller. Last week, he told a bankers meeting that the two countries are in close consultation, and "we do have a little work to do in connection with the yen, which had depreciated too much" since Nov. 1.
The dollar has remained firm despite the frustration of double-digit inflation rates because, as former Economic Council chairman Alan Greenspan explains, "This merely validated the implicit projection of U.S. inflation rates on foreign exchange markets a year ago."
In other words, the current rate of U.S. inflation already has been discounted, and because the rest of the world is considered even more vulnerable to the oil situation than is the United States, there should be little if any further worsening of U.S. inflation rates relative to other countries.
The West German mark has been under some pressure because of rising inflation (stemming from a planned expansion of the economy as well as excessive monetary growth arising from last year's support of the dollar.) And an even lesser-known reason for pressure on all European currencies is that oil is denominated, or sold, in dollars. In some cases, countries have had to hold on to their dollars (or even acquire some) to pay their bigger oil bills.
To illustrate what he called the "complete reversal" of the dollar's international position, West German Bundesbank President Otmar Emminger said last week that in the first five months of this year an equivalent of about 18 billion marks ( $9 billion) had been withdrawn from Germany as the mark weakened. In 1977 and 1978, some 21 billion marks (about $11.5 billion) worth of funds had sought refuge in the then-stronger German currency.
One of the subtle reasons behind the recent administration pressure on the Fed to boost interest rates another notch was to offer an international signal that the Nov. 1 commitment to austerity is still as strong as ever.
Even if the markets had anticipated double-digit inflation here, as Greenspan says, it clearly would be unhealthy if prices appeared to have no ceiling at all. Higher interest rates here have been a bulwark for the dollar, and officials want to maintain the differentials favoring the United States.
And even though higher oil prices affect other nations more than the U.S., it is apparent that the earlier hopes of a reduction of last year's current account deficit from $16 billion to perhaps $2 billion or $3 billion (or even zero) have had to be scrapped.
Rimmer de Vries estimated in the Morgan Guaranty newsletter that this year's current account deficit would be $10.5 billion, narrowing to a rate of $5 billion to $6 billion late this year, "assuming a 25 percent increase in average oil import prices . . . and no real growth in the U.S. economy in the second half of this year."
The latter element-a real, or a growth, recession-is a key element in the general view that the dollar is likely to remain strong. The current jargon is that this "convergence" of growth rates will help to extend the process by which the enormous Japanese and German surpluses are knocked down while the U.S. deficit is being shaved.
To come back to Blumenthal's "appearance and reality" theme, however, the boost given the dollar by recession-which must seem ironic to many citizens-needs a political commitment as well. The moment that Carter is seen to diverge from the Nov. 1 austerity program, the dollar could weaken at the very instant the recession hits bottom.
The mirror image of the Nov. 1 support program for the dollar was its restraint on domestic economic growth. Politically, it meant acceptance of greater risks of recession. At the time, Carter administration officials who shaped the Nov. 1 program resented the public attention focused on this consequence. Now, they assure that, recession or no, Carter will stick with the program.
As for the concern that the dollar will get too strong, Germany and Japan are certain to resist any further dollar appreciation, which would exacerbate, through weaker currencies of their own, already worrisome inflation problems.
For the U.S., the incentive to prevent further dollar appreciation is manifest, although everyone grants that it is impossible to determine with precision what a "correct" or an "equilibrium" rate would be. "Relative stability in the dollar is more important than the level itself," says an internation money expert.
If the dollar goes up more, although it would be far from overvalued, it again would tend to make U.S. exports more costly and imports cheaper. "The dollar had gone down too much, and it should not come back too much now," a European says.
"The U.S. economy has already absorbed the inflationary impact of the weakening of the dollar last year. Now it would be a pity if the advantage you have gained on the export side should be wiped out." CAPTION: Picture, President Carter and Treasury Secretary W. Michael Blumenthal: The end of benign neglect. By Hal Hoover-The Washington Post