Faced with an expected $31 billion merchandise trade deficit in 1977, the Carter administration successfully talked down the dollar in an attempt to improve U.S. exports and stem the flood of imports.
As some former administration officials admit, they may have been too successful. The dollar fell so sharply that the Carter White House had to announce a $30 billion stabilization policy the next year in an attempt to prop it up. The slide finally stabilized in 1979.
The 1977 incident is not lost on many analysts, who said they feared that the attempt this week by the United States, West Germany, France, Japan and Britain to drive down the dollar may backfire.
There are two major concerns. One is that the downward momentum might be so great that the government will be unable to stop it, as in 1977. Letting the dollar drop too far would be harmful because it would undermine confidence in the economy, increase inflationary pressures by driving up the cost of foreign goods and make it more expensive to attract foreign investment that helps defray the budget deficit.
The other concern is that the effort might not work, leaving intact the trade problem that prompted efforts to reduce the dollar's value.
Fears of a rapidly falling dollar were heightened Monday when the announcement of the plan to reduce the value of the dollar produced the sharpest one-day drop in the value of U.S. currency since 1973.
Although the dollar has since stabilized, traders, market analysts and economists said that the course of the initiative, instigated by Treasury Secretary James A. Baker III, is far from certain. It is unclear whether the dollar will withstand attempts by the five governments to drive it down, or whether it will go beyond their targets.
This attempt to influence the value of the dollar is different from past attempts. Rather than working against the dollar's movement, the governments acted to deflate the dollar after it had already started to decline from its record high in February. This suggests that the extra push from the government will simply add momentum to a change already under way.
The United States also has been very vocal in the effort, not only calling for the coordination with the other countries but announcing it with much fanfare in New York last Sunday, signaling to the financial markets that the United States is serious about investing the time and money to push down the dollar.
However, strong forces -- such as high U.S. interest rates, which help keep the dollar high, and the belief by investors that the United States is the safest place to put their money -- work against the dollar's continued decline. Traders say investors will go wherever they can make money and, as long as they believe they can get their best return in U.S. assets, they will remain.
"This latest effort in my estimation is not going to have any fundamental effect on the value of the dollar in the future unless we do some other things," such as encourage other economies to buy more U.S. goods and reduce the federal budget deficit, which has kept U.S. interest rates high, said Thomas Johnson, director of economic policy for the American Enterprise Institute.
High interest rates make U.S. assets financially attractive, which creates a demand for dollars, which makes dollars scarce and runs up the price.
"What it does is it throws a lot of uncertainty, at least in the short run, into the market," Johnson said. "And given the way exchange markets are, uncertainty unsettles them at least temporarily. You can, under those circumstances, put some downward pressure on markets. Traders in the short term don't know what's going to happen tomorrow."
In the past, such attempts by governments to fundamentally change the course of currencies have been deemed failures, yet central banks continue to try, said Stuart Butler, director of domestic policy studies for the Heritage Foundation. However, in some instances, the attempts by central banks may merely be ways of buying time until governments can achieve other policy changes, Butler said.
The governments involved in last week's announcement may have been trying to buy time until protectionist fever in Congress cools, until the administration is able to make a dent in the federal budget deficit, or until foreign governments can improve their economies enough to buy more American goods, Butler said.
"But then you have to ask, how long is it going to take for the French economy to revive," Butler said. "It's not going to take a few weeks. It's hard to see how they can keep the U.S. dollar artificially depressed for that period of time."
C. Fred Bergsten, one of the members of the Carter administration who attempted to push down the dollar in 1977, said he thinks the Baker plan will work because it is fundamentally different from other cases where central bankers and finance ministers have tried to outwit the markets.
"In the past, most of the intervention has been of the leaning-against-the-wind variety," Bergsten said. "In the past, the guideline has been that central banks try to slow down a market movement in a particular direction. In short, they have been moving against the market."
Central banks generally do not try to change the level of the exchange rate. When they do, it is generally in an attempt to reverse the direction of a currency. For example, if the dollar were rising, the role of the U.S. generally would be to try to make it fall.
However, in the present case, the officials are trying to put more pressure on the already weakening dollar, hoping to move it from 240 yen down to about 200 yen, Bergsten said. The dollar on Friday had fallen to about 217.35 yen.
"I have always argued that you have much more success working with the market than against it," he said. "I think it has much more chances of success than in the past."
In 1977, then-Treasury Secretary W. Michael Blumenthal was accused of starting the dollar's decline. There were reports that Blumenthal had called forcefully for a decline in the dollar's value, "but I've never been able to track down" the statement Blumenthal purportedly made about wanting to weaken the dollar, said Robert Solomon of the Brookings Institution. In June 1977, Blumenthal said that he would like to see other currencies appreciate, and shortly afterward the dollar fell, economists said.
"Somehow the word got around that he was talking down the dollar," Solomon said. The dollar dropped about 20 percent the following year, Solomon said.
However, the dollar would not have fallen so sharply if underlying factors such as fear of inflation had not been present, which made investors wary of investing in some U.S. assets and thus reduced the demand for dollars, economists said.
"Economic realities drove it down," Solomon said. The weakened U.S. economy could also help the 1985 effort to push down the dollar, Solomon said.
The slowdown in economic growth had already started to push the dollar down last winter after it reached its high in February, economists said.
Between 1973 -- when most major currencies abandoned the fixed exchange rate system and allowed their currencies to "float" based on market demand and supply -- and 1977, there was little intervention basically because the Ford administration was ideologically opposed to intervening in exchange markets, economists said.
Between 1975 and 1976, the dollar rose because the United States earned a trade surplus of $18 billion. The recession that year, in reaction to the first Arab oil shock, caused imports to drop sharply. The dollar remained strong until 1977, when the Carter administration felt the value of the dollar was too high and was preventing the sale of U.S. goods abroad.
"Talking down" the dollar and the inflationary policies of the Carter administration helped it fall, economists said. "We did succeed, and some would say we succeeded too far," Bergsten said of the 1977 incident. Rampant inflation helped propel the dollar down further and modest intervention in the foreign exchange markets toward the end of 1977 and during 1978 didn't stop the slide.
Intervention didn't work until 1978, when the administration was helped out by the Fed, which increased interest rates, making the dollar more attractive to investors, Bergsten said. With that assist, "We stopped the slide dead in its tracks."