In 1977, Martin Mayer, author of The Bankers and Wall Street: Men and Money, began work on a book about diplomacy. He came to believe, however, that the weakening of the dollar was "among the most obvious reasons for the low efficiency and effectiveness of American international policy" and decided to investigate. This book is the result.
Beginning with the days of the "dollar shortage" after the Second World War and concluding with the change in U.S. monetary policy announced by Paul Volcker on October 6, 1979, he tells us what happend to the dollar under six administrations. All of them sinned, according to Mayer, but some sinned more than others.
The story has been told before -- by Robert Solomon in The International Monetary System, 1945-1976, by Charles Coombs in The Arena of International Finance and by John Williamson in The Failure of World Monetary Reform. But they were insiders, each with his own vantage point. What does Mayer, an outsider, bring to the subject? Profound respect for the opinions of European central bankers, disdain for the U.S. Treasury and most of its inhabitants, dislike for the present monetary system, with its floating exchange rates, and an apparent need to prove command of the subject with excursions into history, theory and technicalities.
Economists talk a language of their own but try to use it precisely. Instead of translating it, Mayer adopts it, then uses it too loosely. Worse, he mixes jargon with metaphor. Back when the dollar was very strong, he tells us, Washington charted a course for "the great armada of getting and spending set on the seas of the postwar world . . ." The United States would run a big trade surplus, "because innovative America would orever be producing things other countries couldn't make," and the dollar could be safely "overvalued" as an international currency. The trade surplus would be covered by U.S. aid, private investment abroad and military spending. In fact, these outflows would be larger than the trade surplus so that the United States would run a payments deficit. "The trade surplus would keep the dollar overvalued while the payments deficit would help prevent inflation in America by pulling dollars out of the country."
The United States did run a trade surplus for more than two decades, and the gap was more than offset by aid, investment and other outlays, producing a payments deficit. But the pattern was not planned omnisciently in Washington and did not serve the purposes described by Mayer. The payments deficit, for instance, did not combat inflation because it did not drain dollars from the United States. (This was indeed the Europeans' chief complaint about the monetary system -- that the special role of the dollar insulated the United States deflantionary pressures.)
But all of this is ancient history. What went wrong thereafter? Mayer is not sure. At times, he seems to endorse Robert Triffin's diagnosis, that the growth of dollar holdings in foreign hands was bound to undermine confidence in the dollar. Yet this diagnosis does not explain the weakening of the trade balance so much emphasized by Mayer -- the shift into deficit that triggered the crisis of 1971 and the reappearance of the deficit in 1977 that produced the long slide of the dollar exchange rates in 1977-1979. At times, Mayer blames "benign neglect" by U.S. Officials (for which in turn, he blames the theories of Robert Mundell, and gets them wrong in the process). In the end, he decides that the weakness of the dollar is "partly technical, partly systemic, partly and expression of worldwide political and economic change that cannot be escaped and should not be fought."
Complaints about benign neglect are not hard to justify. I do not share Mayer's dislike of floating exchange rates. In words used by Richard Cooper and quoted by Mayer, "My view of floating rates in Churchill's view of democracy -- the worst system except for all the others." From the start of floating in 1973, however, until November 1, 1978. U.S. policy left too much to the foreign-exchange markets, and the dangers of inflation were not given enough weight in the first two years of the Carter administration, so that floating rates had too much work to do. To make matters worse, our public posture infuriated European governments, whose economics are much more vulnerable to the cost of exchange-rate fluctuations. By declining to participate in the management of the float, apart from occasional interventions to combat "disorderly" conditions, the United States lost any standing to criticize its partners for the way in which they were managing the float.
But the Carter administration does not deserve Mayer's scorn for asking Europe and Japan to adopt bolder economic policies. It is easy to make fun of the rhetoric -- locomotives, convoys and all that -- but harder to fault the aim of the excercise. And Mayer fails to point out that the weakness of the dollar in 1977-1979 was due partly to mismanagement in earlier years. If the dollar had been allowed to depreciate modestly in 1976 and early in 1977, the U.S. trade balance would have been stronger in 1978 and 1979, and the subsequent depreciation would have been milder. But the foreign central banks for whom Mayer has great respect intervened to prevent the requisite depreciation.
Furthermore, Mayer is inconsistent in his objections to benign neglect. He is comparatively kind to the Kennedy adminstration, yet that was the period in which the U.S. Treasury was most clearly determined to postpone any reckoning with the payments deficit. It erected "perimeter defenses" for the dollar and tried to finance the deficit without large gold losses. It did not take corrective action. The Kennedy administration was not necessarily wrong, given views and prospects at the time. Economists at the Brookings Institution were not alone in believing that the balance of payments would improve by itself, and it was on the way in 1964-1966, before U.S. economic policy went awry. But Mayer also fails to remind us of these circumstances. Elsewhere, Mayer praises Paul Volcker for his monetary policies which, he says, amount to saying that "domestic considerations would have to take precednece over the Foreign-exchange markets . . ." This is not so, but if it were, it would be benign neglect of the most blatant sort.
Mayer has interesting stories to tell. If accurate, they fill some puzzling gaps in the history of the dollar. The "gold rush" of 1960-1961, for instance, was precipitated by ambivalence in Washington and by British reactions to it. The decision to close the gold window in 1971 may have been due in part to a misunderstanding between Paul Volcker and John Connally. But anecdotes do not make analytical history, and that is what Mayer undertakes to provide.
What should be done about the dollar? Mayer makes an number of recommendations, most of them familiar and some of them sensible, but one of them puzzles me. He has his own theory of bureaucratic politics. In the Carter administration, he maintains, policy errors were made because talented people were slotted into the wrong jobs. More important, the Treasury should not have responsibility for managing the dollar. It should stick to raising revenue and managing the federal debt. Defense of the dollar should be left to the Federal Reserve System. All over the world, Mayer says, "central banks are kept separate in some degree from the political process" and can thus be entrusted with defense of the currency. But Mayer is wrong on two counts, Most central banks have less independence than the Federal Reserve System, and on his own reading of the record, the Fed has not done very well. It was wrong in 1972, under Arthur Burns, when it fostered rapid growth in the money supply and thus undermined the Smithsonian agreement, and was wrong again in 1977-1978, under G. William Miller, when it failed to combat inflation.
If you decide to read this book, be self-confident. Those things that puzzle you may be wrong, not beyond your grasp. On two occasons, Mayer says that the U.S. authorities were buying marks. They were selling marks. At several points, he confuses the role of the dollar in the foreign-exchange markets, where it serves as a "vehicle" for movements between other currencies, with the reserve role of the dollar, and he compounds the confusion by turning it into a case for fixed exchanges rates. At another point, Mayer tries to lead his readers through the several definitions of the balance of payments -- a matter of theology on which I have wasted too much of my own professional life. He wastes his readers' time and misleads them too. The "liquidity" deficit, he says, is "the net change in liquid claims held by foreigners against the United States before 'settlement' of any of those claims through transfers of reserve assets . . ." Understand? No you don't. It is net of changes in reserves used to settle claims. But it doesn't really matter anyway.