Statements emanating from Washington this past week concerning the value of the dollar, the economy, the direction of interest rates and inflation all had a definite bias to them.
Treasury Secretary James A. Baker III spoke for the administration when he declared that interest rates should go lower. He was trying to diffuse even more the protectionist movement on the Hill that came about from the high interest rates and the strong dollar of the early 1980s. The strong dollar was largely instrumental in leading to two successive years of massive merchandise trade deficits that, in the process, helped to decimate the manufacturing sector of the U.S. economy.
An outgrowth of this situation has been strong sentiment in Congress to place protective legislation on the imports of our trading partners like Japan and China. Such "protectionism" played a large part in causing our economic and financial woes of the 1930s. So it is understandable that the Treasury secretary would like to see the dollar and interest rates decline more, not only to head off any protectionist legislation but also to help stimulate the domestic economy, which has been languishing.
On the other hand, Federal Reserve Chairman Paul A. Volcker will go down in history as the person who broke the back of inflation during 1979 and the early 1980s. That was an enormous feat, but the price in winning the war was extremely high. Although inflation now may be dormant, the "great inflation fighter" does not wish to afford inflation any opportunity to rise from the mat. Consequently, when Volcker states that a 35 percent decline in the dollar may be enough for now, we understand his perspective.
If, in fact, the dollar continues too rapid a decline, foreigners will increase the prices of their exports to the United States to make up for the dollar loss on their products from the dollar devaluation. At the same time, the higher cost on these imports will allow U.S. producers some room for extra price increases on their domestic goods. The end result is a slow resumption of inflation.
Richard Scott-Ram, an economist at Nakagama and Wallace Inc. in New York, feels that the way events are now, inflation may not be a problem for awhile. He points out the sources of inflation in the 1970s were: 1) big money supply growth, but not much in M1 and M2 now; 2) oil price inflation, but oil prices are plummeting now; 3) food price inflation, but agriculture is in a recession; and 4) wage inflation, which is showing minimal increases nationwide.
All this is good for inflation and for bonds as well.
On Wednesday, the Treasury will auction five-year notes in minimum denominations of $1,000. The return should be approximately 8.15 percent.