BAKER, VOLCKER ACTIONS QUESTIONED

The finance ministers and central bank governors of the larger industrial countries met in Paris over the weekend of Feb. 21-22 and agreed to cooperate closely to foster stability of exchange rates around current levels.

The essence of the bargain that was struck was that West Germany and Japan will adopt mildly expansionary measures in return for the willingness by the United States not only to concede that exchange rates are now broadly consistent with underlying economic fundamentals but also presumably to cooperate in exchange market intervention if necessary to keep rates within their present ranges.The main question raised by this agreement is, why did Secretary of Treasury James Baker III and Federal Reserve Board Chairman Paul Volcker accept it when there are good reasons to believe that additional depreciation of the dollar will be needed and when the policy measures promised by West Germany and Japan are rather modest?

It is not difficult to demonstrate that the dollar has not depreciated enough to eliminate the deficit in the U.S. balance on current account.

That deficit was caused mainly by the huge appreciation of the dollar that took place from 1980 to early 1985. The Federal Reserve's index of the trade- weighted average value of the dollar against the currencies of other industrial countries has reversed about five-sixths of that appreciation. According to an index compiled by Morgan Guaranty, which includes developing as well as industrial countries and is adjusted for differential rates of inflation, less than three-fourths of the earlier real appreciation had been undone in January.

Even if the dollar were back to where it was in 1980, that would not be sufficient to restore balance to the current account of the United States. The

dollar has to depreciate more because it now requires a more favorable trade balance to achieve any given goal for the current account.

The string of current-account deficits in this decade will probably cumulate to something like $750 billion before they are eliminated. These deficits alter the net investment position of the United States. That position will have moved in the negative direction by $750 billion.

If the average return on net U.S. debt and equity claims held by the rest of the world is 7 percent, that would add about $50 billion to our net payments abroad of interest and dividends. To compensate for these additional investment income payments, we will need a trade surplus $50 billion larger than in 1980.

It might be argued that the oil price and the dollar value of oil imports are lower than in 1980 and this calls for less dollar depreciation. But we do not know where the oil price will be a few years from now and we do know that the volume of oil imports will be increasing.

Moreover, the case can be made that achieving balance in the current account is a minimum re quirement. The wealthiest country should have a current-account surplus and therefore be in a position to export capital on a net basis to less affluent countries.

It follows that additional depreciation of the dollar will be needed. That depreciation need not occur immediately. The exchange-rate adjustment that we have had in the past two years is sufficient to start the process of reducing the U.S. deficit and the surpluses of other countries. But that process will not go far enough at current exchange rates.

The other questionable aspect of the Paris agreement concerns the policy actions promised by West Germany and Japan. For some time now Secretary Baker and Chairman Volcker have been calling for more expansionary policies in these countries. What they have settled for does not appear to amount to much.

The West German authorities will do nothing until next year, when they will add somewhat to the tax cuts that were already scheduled to take place. Japan will continue to implement the austere budget proposals for the fiscal year that begins next month. After that, it is promised, a comprehensive economic program will be prepared . . . so as to stimulate domestic demand, with the prevailing economic situation duly taken into account.

Thus the quid pro quo to Secretary Baker for his willingness to sign on to a statement that the dollar has gone down enough appears to be neither immediate nor substantial. Why did he do it?

Two answers may be suggested. One is that he fears that the present degree of appreciation of the German mark and the Japanese yen will create very sluggish economic conditions, if not recession, in Europe and Japan. That would be in no one's interest. Therefore it makes sense to have a pause in the depreciation of the dollar and the corresponding appreciation of other currencies. During that pause, perhaps the surplus countries, especially West Germany and Japan, will adopt stronger policies.

The other possible explanation for the secretary's decision is political. He feared that the report of the Tower Commission would weaken even further confidence in the Reagan presidency and could lead to a rapid and destabilizing decline of the dollar. To prevent that he wanted an international agreement to underwrite the dollar's exchange rates and did not care how much he got in return.

Either of these suppositions as to the motivation of the Americans at the Paris meeting leads to the judgment that the present agreement to stabilize the dollar is temporary.

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