The dollar's steep decline in 1987 -- and the perceived failure of the United States and its allies to halt the plunge -- has generated a new debate on the wisdom and benefits of international economic cooperation.
The expanded policy of cooperation launched by Treasury Secretary James A. Baker III reached a high point last year with the signing of the Louvre Accord in Paris, an attempt to guarantee stability for the foreign exchange value of the dollar.
But the cost for a degree of dollar steadiness in 1987 was a soaring U.S. interest rate level, which raised the threat of a serious recession and helped to trigger the stock market collapse on Oct. 19.
To be sure, there were other root causes of the October market crashes around the world, notably the underlying trade and current account imbalances among the Big Three nations -- the United States, West Germany and Japan. But the fact that these imbalances persisted is a commentary on the fragility of the cooperative process.
From the start, Baker warned that the international policy coordination effort he attempted to put together in 1985 had to be viewed as incremental, one that would be accomplished only with painfully slow steps.
But even accepting this caveat, there are those, such as former economic council chairman Martin Feldstein, who now contend that the United States should "explicitly but very amiably abandon the policy of international macroeconomic coordination."
Feldstein told the House Banking Committee 10 days after Black Monday that "the public needs to be reassured that we are not hostages to foreign economic policies, that the United States is the master of its own economic destiny, and that our own government can and will do what is needed to maintain healthy economic growth."
Henry Nau, a former member of the National Security Council staff, adds that the coordination process Baker launched substituted "global activism" for concrete steps to reduce the U.S. budget deficit, and as a result probably encouraged Japan and West Germany to resist American demands that they stimulate economic growth.
Another skeptic, Stanley Fisher, new chief economist for the World Bank, said in an interview that "the impact of one major country's policies on another is relatively small... . In a political context, there may be a reason for a coordinated strategy, because it may be easier for everyone concerned to come up with one set of policies, on condition that all act together. But if we ask what will really improve the U.S. situation, it's basically U.S. policies. They give a bigger bang for the buck."
Feldstein's and Fisher's voices are still in the minority: The conventional wisdom is that today's global economy requires cooperation, and that if the mechanics haven't worked perfectly to date, the baby shouldn't be thrown out with the bath water. Instead, the majority say, improve the system.
Federal Reserve Board Chairman Alan Greenspan, who as a private citizen had reservations about what could be accomplished through joint international efforts, feels that the potential for success is greater than it was a couple of years ago. Moreover, Greenspan and other insiders hint that more coordination actually takes place than the press and public are aware.
Canada's top international economist, Sylvia Ostry, thinks the Louvre Accord may have given international cooperation a bad name by placing undue emphasis on exchange rate stability. In effect, Ostry suggests that the finance ministers made a contract they couldn't fulfill. But she and others say that this is hardly the time to take Feldstein's advice. "We shouldn't abandon the process, but attempt to make it more credible and effective," she said.
In a monograph written with British economist Michael Artis, Ostry said that "today, more than ever before, the economies of the world are clearly highly interdependent." They argue that that developments in any major country, or actions by any economic power have important implications for all: Especially in an age of instant communication and 24-hour global markets battered by huge capital movements, no country can live in a vacuum.
The internationalists say that Black Monday -- rather than disproving the case for a global economy -- demonstrated its reality in dramatic fashion when the crash rocketed east and west to Asian and European markets.
"This is one market," said investment banker Nicholas S. Brady, who headed a presidential task force on the reasons for the crash. "We have 300,000 screens around the world connected by electronics and technology ... and we're not talking about individual marketplaces. We're talking about one market that those screens and electronics put together."
Brady's observation has equal applicability to the bond and the dollar exchange markets: National boundaries still exist for customs, tariff, visa and passport purposes. But informational flows and the electronic transfers of capital don't have to stop for border checks.
Under Baker's leadership, the United States made an effort to improve the process of economic policy coordination, so as to lend stability to global economic affairs.
Spurred in late 1985 by the realization that an overvalued dollar was creating havoc for American industry, and therefore had boosted the trade deficit to unacceptable levels, Baker persuaded four other governments at the Group of Five meeting at the Plaza Hotel in New York to join forces in an effort to push the dollar down.
Ironically, this reversal of the Reagan administration's first term policy of letting the market determine the dollar's value -- which played a role in creating the huge trade imbalances of the 1980s -- was triggered by another aspect of the president's free-market philosophy: Because of the huge trade deficit, the nation was clearly headed toward a new burst of protectionist trade legislation. That, the president wanted to avoid, even at the cost of manipulating exchange rate relationships.
For a time, the Group of Five alliance -- the United States, Japan, West Germany, France and Britain -- seemed to do well. The dollar dropped sharply against the Japanese yen and West German mark, even if the trade deficit persisted and grew. Henry Nau and some others insist that the dollar came down in 1985 and 1986, less because of the Plaza Accord, and more because U.S. monetary policy turned easier than that followed in Frankfurt or Tokyo -- and because oil prices collapsed.
By late 1986, the question had become how to stop the slide of the dollar -- with Baker still actively talking it down, and the other G-5 partners working at cross purposes with the United States. Expanded to a Group of Six, incorporating Canada, the finance ministers and central bankers agreed at the Louvre Palace in February 1987 to stabilize exchange rates at around then-current levels. Baker promised to quit talking the dollar down, in exchange for a pledge from the West Germans and Japanese for a solid domestic expansion, calculated to reduce the U.S. trade deficit.
It can be seen in retrospect that at the Louvre, Baker and former Fed Chairman Paul A. Volcker were less worried about higher interest rates that would be needed to stabilize the dollar than the potential negative effects of a lower dollar in this country, and in Asia and Europe.
By the time of the October crash, Baker and a new Fed chairman, Alan Greenspan, had to reverse that position: By then, Baker was convinced that the higher interest rates needed to keep the dollar from falling further would trigger a U.S. recession, an obvious threat to the Republican Party in the presidential election year of 1988. Baker opted to let the dollar slide through the October crash period, and didn't join in a G-7 effort to call a halt until Dec. 22.
It is clear, in summary, that the goals of the G-5 and the G-7 have not been completely achieved: The demonstrable fact that a global economy does exist has not been compelling enough to persuade national politicians to put that One World need ahead of the demands of their own constituents. There is much talk, but less action.
In the United States, the commitment made by Baker at the Plaza meeting and revived at the Louvre to push the American budget deficit down could not be fulfilled. "Baker," said New York financial analyst Sam Nakagama, "couldn't deliver Reagan." Japan was unwilling to boost its domestic economic activity (although more recently, it has begun to do so.) And the West Germans, with passionate -- some say irrational -- attention to the dangers of inflation, failed to expand their domestic economy as Baker says he was led to believe they would.
After the Louvre, all of the nations intervened, to some extent, to support the dollar. This process was repeated early in January after the markets ignored the Dec. 22 G-7 statement asserting that the dollar had declined enough. But otherwise, only lip service has been paid to the international cooperative process: What kept the dollar stable in 1987 for much of the year -- until the October stock market crash -- was a drift to higher interest rates in the United States.
The only other possible route to salvage the Louvre Accord's commitment to stable exchange rates would have been for West Germany to seize leadership. With lower interest rates and a sizable fiscal thrust, the Germans could have given a substantial boost to their own economy, to Europe, and to the global economy.
Despite persistent pressure from Baker, the West German government refused to act, asserting that it could not take the domestic political risk of starting a new inflation. It resists the idea that the West German economy can or should be "a locomotive" for the rest of the world. Moreover, the government there is opposed to major economic reforms in West Germany that might redistribute wealth. It is happy with a slow growth policy, despite the urgings, as well, from its European Community partners that would benefit from boosted trade to a more exuberant West Germany economy.
What was a private contretemps became public when Baker blasted German inaction on the weekend before Black Monday, asserting that the United States would not boost interest rates further in order to maintain its Louvre commitment for dollar stability. So once again, national values took precedence over the international imperative: If West German priority focused on inflation control, the U.S. priority was to avert recession -- and possibly give a bit of help to a Republican presidential candidate in 1988.
There seems to be little doubt that stock market participants correctly read the Baker denunciation of West German policy: at that point, international cooperation had come to a screeching halt, and that fact was factored into the negative forces pulling the market down.
"There is an argument," says Ostry, "that the Louvre Accord placed enormous and maybe undue emphasis on exchange rates, and in some sense, that was the real reason behind the market crash."
As a result, therefore, support for economic coordination has wilted, even in official circles. Some central bankers among the G-7 participants doubt their own ability to manage"This is one market. We have 300,000 screens around the world connected by electronics and technology ... and we're not talking about individual marketplaces. We're talking about one market that those screens and electronics put together." -- investment banker Nicholas S. Brady the international economy as completely as Baker had envisaged at the Plaza Hotel. West German central bank president Karl Otto Poehl, for example, has not only expressed reservations about the degree to which the Plaza Accord should get credit for driving the dollar down, but argues that the G-7 had mistakenly begun to stress stable exchange rates as a goal in themselves.
"What we are really aiming at is a coordinated process of noninflationary growth," Poehl said in a New York speech on Nov. 2. "It is less ambitious but more realistic to concentrate on managing the existing system pragmatically and flexibly." Poehl also questions Baker's idea that policy differences can be narrowed by using automatic "objective indicators," and was openly critical of Baker's trial balloon for including gold in a commodity index that would be designed to hoist a warning signal about inflation.
Ostry suggests that some rethinking needs to be done, perhaps along the lines of Poehl's comments. Thus, instead of looking for "target zones" in which to manage exchange rate levels, the goal for international cooperation in the next few years may be pared back to the less ambitious notion of trying to harmonize the growth of nominal gross national product.
At this stage, it is an open question whether the dollar can be held stable without further steps here, in Europe and in Asia to coordinate underlying economic policies, with or without intervention.