The sky-high dollar symbolizes the economic illusion of our time: the belief that we can control things. Against the currencies of other major industrial countries, the dollar is now 40 percent higher than in 1980. The 1984 trade deficit -- partially as a result -- is expected to exceed $100 billion. A few years ago, neither development was planned or predicted. The dollar exchange rate is one of our main economic levers, and yet no one is quite sure how it's determined, let alone how it could be easily controlled.
The effects of the high dollar can be argued endlessly. I believe that, on balance, it's been good. The frequent charge that it has destroyed 2 million jobs is nonsense. Inexpensive imports have cut inflation, which has helped recovery. Since November 1982, employment has increased by 6 million. Historically, there's little connection between trade deficits and jobs. The last trade surplus occurred in 1975, a year of high joblessness.
But I'll admit that it's easy to make a contrary case. Industries and farmers that compete in world markets have been devastated by the high dollar. It means that foreigners can buy less in dollars with their local currencies. A bushel of wheat that cost $3.91 or 7 West German deutsche marks in 1980 would cost about 12 marks now. So demand for and prices of American goods in world trade have sagged. Despite the recovery, the production of American industrial machinery is still below its prerecession peak.
My point is not to debate the pros and cons of the high dollar. Almost everyone can agree that the economic effects -- the good one on inflation, the bad one on farmers and manufacturers -- are huge. The more basic point is that these immense changes have resulted from forces that we only crudely control or understand. For want of a better term, call them the globalization of financial markets.
Businesses, banks, wealthy individuals and institutional investors (insurance companies, pension funds) increasingly deploy their funds in securities denominated in different currencies. This evolution reflects developments that governments are almost powerless to stop. As business has become more global, multinational companies accumulate earnings in different currencies; they cannot avoid deciding which to hold and which to sell. Likewise, modern communications make it easier for all large investors to diversify their portfolios in different national securities.
The upshot is to alter how markets work. By the old books, our trade deficits and high dollar should have corrected themselves. Exchange rates reflect supply and demand for currencies. A trade deficit, it was argued, would create an excess of dollars. More dollars would be sold to buy foreign currencies to pay for our imports than would be demanded -- at the existing price -- to pay for our exports. The dollar's price would drop and so would the trade deficit. Our imports would become more costly; our exports, more competitive.
But the demand for dollars to invest in dollar securities -- bonds, Treasury securities or bank certificates of deposit -- has overwhelmed this logic so far. The result is that, as a nation, we're spending more than we're producing. We're receiving products and services from other nations and giving pieces of paper, dollars, in return. This paper-for-goods game is possible because the rest of the world is, for the moment, hot for American paper. There has been a rush toward dollar securities since 1982, says Roy Smith of Goldman, Sachs & Co.
How long can it go on? There's the mystery. Because there's no convincing explanation of the high dollar demand, it's not easy to predict when it will abate. The pat explanation of high American interest rates is limp. Our rates were also higher in the late 1970s, but the dollar dropped then. The reason higher rates don't boost a currency automatically is so-called exchange risk. Consider a German investor who's switching funds from a mark bank deposit to a dollar deposit. In mid-October, the dollar interest rate was 11 percent compared with a 6 percent mark rate; over a year, the German might make a 5 percent profit. But if the dollar depreciates 5 percent in the year (meaning it will buy 5 percent fewer marks), there's no gain. And if it depreciates more than 5 percent, there's a loss.
So today's dollar investors implicitly believe the dollar won't depreciate significantly. They could be wrong. Most of the factors cited for the high demand are unprovable and could be temporary: They include confidence in the Reagan administration, lack of confidence in European economies, and a flight of funds -- converted into dollars -- from Latin America and the Middle East. Exchange markets are unpredictable and volatile, as economist Jacob Frenkel of the University of Chicago says. They react like stock markets: Good news about a company may cause its stock price to rise; as it rises, more investors want to buy, sending the price higher. The same bandwagon effect makes exchange rates erratic. When a currency is strong, buying demand rises -- and vice versa.
If the dollar begins to drop, the process could feed on itself. How much it might drop and what the economic effects would be are difficult to say. American export competitiveness would improve; our inflation might not. But the Europeans and Japanese complain that the high dollar forces them to keep their interest rates up to prevent their currencies from dropping too much. A lower dollar might lead to lower interest rates and, thereby, spur growth.
If the outcome seems obscure, that's the point. It explains why, I think, we clutch our economic illusion: that things are, or can be, controlled. It's not that we're entirely powerless: The basic reason for a strong dollar probably lies with the Federal Reserve's reversal of its lax inflationary policies of the late 1970s. But the consequences of this shift went much farther than anyone predicted and for reasons not well understood. We are loath to admit these simple truths. As a people, we like to think we're masters of our destiny. But it ain't necessarily so.