The U.S. dollar sank to postwar lows against the Japanese yen and the West German mark Thursday after the Reagan Administration signaled a willingness to let the dollar fall abroad in an effort to avert a recession at home.
Economists said the position indicated that the White House is ready to face the inflationary risks of a falling dollar to avoid or at least mitigate a domestic recession in 1988, an election year.
"Politically, the Administration has little choice but to do what they are doing," said James Van Horne, a finance professor at the Stanford Business School. "You can't allow a serious recession to develop and hold the U.S. economy to hardship to prop up the dollar."
The dollar's continued decline will increase the cost of imports and make American goods cheaper abroad, which should begin to further ease the nation's trade deficit in about a year.
Sooner than that, however, the rising cost of imports will increase inflationary pressure and restrict the export market for America's trading partners.
The new lows follow the dollar's steady deterioration since the stock market crash on Oct. 19. The Administration could defend the dollar by raising interest rates, thus making it more attractive to foreign investors. But that would step up the chances of a serious recession by restricting consumer and business spending.
Lowering interest rates is viewed by economists as a means of stimulating the economy to help avert a serious recession and restore some confidence in the stock market.
Stocks Move Higher
"Right now, it is important to make sure the sharp decline in the stock market does not have a dramatic effect on the entire economy," said Kathleen B. Cooper, chief economist for Security Pacific National Bank in Los Angeles. "You have to be concerned about the psychological effects."
The market responded with a 40-point surge in the Dow industrials Thursday that coincided with the dollar's drop.
In New York, the dollar reached the lowest point in the 39-year history of the mark, breaking the psychological barrier of 1.7000 and ending the day at 1.6767, a decline from 1.7045 on Wednesday. The dollar also reached a new low of 135.10 yen, down from 136.70.
The dollar tumbled in London against the British pound to a five-year low of $1.7850, compared to $1.7480 on Wednesday. In New York, it cost $1.7798 to buy one pound, more expensive than $1.7540 on Wednesday.
Other late dollar rates in New York included: 1.3780 Swiss francs, down from 1.4050; 5.6650 French francs, down from 5.7960; 1,234.00 Italian lire, down from 1,260.00, and 1.3246 Canadian dollars, down from 1.3254.
Gold fell to $457.50 an ounce on the New York Commodity Exchange from $466.20 on Wednesday.
Avoiding Recession Key
The dollar's decline occurred despite attempts by the central banks of West Germany and Japan to defend the dollar. The Germans lowered interest rates, which should make the dollar more attractive, and the Japanese bought heavily in the dollar market.
The broad losses came after the White House affirmed support for statements by Treasury Secretary James A. Baker III that the Administration's top priority is avoiding a recession caused by higher interest rates.
In an interview published Thursday in the Wall Street Journal, Baker was quoted as saying he wants to "make sure" that the Federal Reserve keeps "sufficient liquidity" in the monetary system. The statement, interpreted as a signal that the Fed's easy money stance would continue, triggered an immediate drop in the dollar in Europe. It was already down in Japan.
The decline continued after Marlin Fitzwater, the White House spokesman, confirmed that Baker's statements reflected the Administration's determination to avoid a recession. Later, Fitzwater released another statement saying the Administration supported "exchange rate stability," but it was not sufficient to reverse the decline.
Economists generally supported the Administration's position.
"You can't support both the economy and the dollar, and if you have to choose between the two, then the economy is obviously the most important," said David Wyss, chief financial economist for Data Resources, an economic forecasting firm in Lexington, Mass.
Kenneth Ackbarali, a senior economist at First Interstate Bank in Los Angeles, said the effects could be seen soon in American markets.
"There will be benefits to the manufacturing sector, since our export demand should pick up," he said. "But it will also mean, with longer lags, higher import prices and lead eventually to higher inflation."
U.S. consumers are already paying more for Japanese cars and electronic goods as a result of more than two years of much slower declines in the dollar, compared to the yen. Even before the market crash and ensuing financial disruption, First Interstate was forecasting a slight increase in inflation next year.
Among those who viewed the Administration's action with alarm was Stephen Marris, an economist with the Institute for International Economics in Washington. He said the Administration position creates the possibility for an enormous drop in the dollar unless progress is announced very soon on steps to deal with the fiscal deficit.
"If you try to devalue your currency without at the same time taking a good measure of austerity, it is a recipe for disaster," Marris said.