WASHINGTON — Last week, the Reagan Administration's chief economic policy maker, Treasury Secretary James A. Baker III, said the government would do nothing to prevent the dollar from falling. This week, President Reagan said he wants the dollar to stabilize.
What exactly is going on? Confusion over the dollar is rampant, reflecting sharp differences over policy inside the Administration and the difficulty of trying to avoid an economic downturn in the wake of last month's stock market crash.
At bottom, the United States is currently in no position either to push the dollar down or to hold it up. The result is that the dollar will move for now primarily in response to marketplace speculation.
So what? For most Americans, unless they take a foreign vacation, the level of the dollar in international currency markets seems far removed from their daily lives. But the uncomfortable reality is that the dollar's value is a central factor in determining the U.S. standard of living.
The U.S. currency was exceptionally strong during the first half of the 1980s because foreigners, for a variety of reasons, were eager to hold the dollars Americans paid for foreign goods. That allowed the United States to live far beyond its means--to buy much more from abroad than it was required to ship overseas. But the strong dollar priced U.S. manufacturers out of world markets and fueled a dramatic increase in the nation's trade deficit.
Now everything is changing. Foreign investors are increasingly reluctant to accumulate rising amounts of dollars. The dollar has fallen from its Himalayan peak of early 1985.
Gradually or suddenly, that means the U.S. trade deficit will have to shrink, Americans will have to consume less, and standards of living will be squeezed.
The causes and effects are complicated and interrelated. Here, in question-and-answer form, is why every American will feel the effects of the dollar's fall.
Q: Does the United States benefit when the dollar falls?
A: Yes, in one major way: A cheaper dollar helps reduce the U.S. trade deficit. That is because Americans have to pay more dollars to buy imports, while foreigners can buy U.S. goods more cheaply.
Q: Why was the dollar relatively stable against other major currencies for most of the year?
A: For most of this year, the United States cooperated with other major industrial nations to help stabilize the dollar at roughly the levels agreed upon last February at a meeting in Paris. The Federal Reserve, as part of the bargain, defended the dollar by gradually pushing up U.S. interest rates to encourage reluctant foreign and domestic investors to keep their holdings in dollar securities. The Fed and other central banks were also helping by buying dollars in world currency markets.
Q: If a falling dollar helps the trade balance, why would the United States want to stabilize the dollar?
A: Because a falling dollar is inflationary. By February, the dollar had already been falling for two years, and that meant U.S. consumers had to pay more and more dollars for foreign goods. In particular, Paul A. Volcker, who was then chairman of the Federal Reserve, worried about the effect of a falling dollar on inflation.
More than that, the Reagan Administration thought it could narrow the trade deficit even if the dollar remained stable. It was counting on European countries and Japan to stimulate their economies so that their citizens could buy more U.S. goods. If the dollar fell too much against those countries' currencies, exporters in Europe and Japan might lose so much business in the United States that their own countries would plunge into a recession and cut back even further on their purchases from the United States.
Q: So what started the dollar's recent fall?
A: It began with another disappointing monthly report on trade. When the government reported on Oct. 14 that the trade deficit for August was higher than expected, the dollar fell. That's because the traders who move an average of $200 billion a day around the world in search of the best return were convinced that the Fed would be under pressure to let the dollar fall to help reduce the trade deficit. Not wanting to hold depreciating dollars, the traders sold them in massive amounts.
Q: But isn't the federal budget deficit, not the dollar, to blame for the continuing trade deficit?
A: Not really. Practically every country has a budget deficit and if budget deficits led automatically to trade deficits, every nation would run a trade deficit, which is impossible.
More to blame, strangely, is the dollar's role as a global currency. For a long time, foreigners who earned dollars by selling goods and services to the United States were only too happy to keep their dollars and invest them in the United States instead of converting them into their own currencies.