ECONOMIC SCENE; BAKER, VOLCKER AND THE DOLLAR - Ne...

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March 25, 1987

ECONOMIC SCENE; BAKER, VOLCKER AND THE DOLLAR

By LEONARD SILK

LEAD: THE dollar has been falling again against the yen and the mark despite the Paris agreement among the ''Group of Six'' of Feb. 22 to stabilize the dollar about where it was then. THE dollar has been falling again against the yen and the mark despite the Paris agreement among the ''Group of Six'' of Feb. 22 to stabilize the dollar about where it was then. Traders said the dollar was driven down this week by Treasury Secretary James A. Baker 3d, who said on British television that the United States did not have a target for the dollar's value. Does this imply that Mr. Baker is unhappy with the way other countries are fulfilling their commitments, public and private, to cooperate in helping to narrow the American trade deficit and is subtly talking the dollar down? Or does the downslide of the dollar simply indicate the judgment of markets that the American currency is still overvalued and that Government intervention is too feeble to overcome the tidal flows of private capital? These are not mutually exclusive explanations. Mr. Baker does not seem bursting with joy over the cooperation the United States is getting from its allies. The Japanese Government, while talking about tax reform to stimulate the economy, is also proposing to raise sales taxes, which would cut domestic consumption, spur savings and very likely increase the flow of Japanese capital abroad. Last week the Reagan Administration brought pressure on Fujitsu Ltd. to drop its plan to buy the Fairchild Semiconductor Corporation. The apparent toughening of American trade policy and the implicit threat of further dollar devaluation remain. But official threats are less powerful than market forces. And the market's belief that the dollar is still overvalued, according to George R. Perry, a senior fellow at the Brookings Institution, is supported by two considerations. First, the current-account deficit of the United States continued to widen last year. Even though the dollar has now fallen back to its 1980 level, Mr. Perry contends that econometric analyses indicate that the dollar must now fall much more to restore equilbrium to the current-account position. Second, dollar holdings of foreign governments and central banks rose by $41 billion in 1986 and kept rising this year; that represents their intervention in currency markets. Hence, at the exchange rates that prevailed last year, private capital inflows to the United States were not enough to finance its current-account deficit. ''Without official intervention,'' Mr. Perry said, ''the dollar would have fallen even further than it has.'' Two other Brookings economists, Ralph C. Bryant and Gerald Holtham, also think the dollar has not declined enough to eliminate the trade deficit. They contend that in substance the Paris meeting last month ''fell well short of its rhetoric on cooperation'' and that the commitment by Germany and Japan to expansionary policies is not enough to validate the dollar's current value. They see ''soggy'' prospects for real growth in Europe and Japan in 1987-88. But the whole cause of the American trade deficit does not lie abroad; they also stress America's ''bloated'' budget deficit. Dollar devaluation is no cure-all. And, if the dollar fell precipitately, that would generate inflationary pressures, choke off foreign investment, drive up interest rates and probably plunge the United States and

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world economy into deep recession. The chief guardian against a free fall of the dollar is Paul A. Volcker, chairman of the Federal Reserve Board. He told Congress that the United States had largely escaped the adverse consequences of the ''insidious combination'' of low savings rates and high Federal deficits by drawing on capital from abroad; its flow last year exceeded all the savings by United States households. That situation, Mr. Volcker said, cannot last: It is not sustainable economically to pile up foreign debts while failing to make the investments needed to generate growth and earn the money to service the debts; it is not sustainable politically, as pressures on the American industrial base are transmuted into demands for protection, and it is not sustainable internationally, as the confidence that underlies the flow of foreign savings will be eroded. ''Sooner or later,'' Mr. Volcker said, ''the process will stop. The only question is how.'' Meanwhile, however, the economy advances, foreign capital flows in and stocks booms. And the key policy makers, aware of the dangers, play different but complementary roles: Mr. Baker leans on foreigners to speed up their growth and cut their trade surpluses or see the dollar decline; Mr. Volcker leans on Americans to live within their means, tells Congress to cut the deficit and seeks to cushion the fall of the dollar - ''Enough is enough,'' he said yesterday. Mr. Baker urges growth, Mr. Volcker stability. This is not just Good Cop, Bad Cop; it is also Mr. Outside, Mr. Inside. The markets are still betting that Mr. Baker and Mr. Volcker will get America's act together. But they will need the support of the President and Congress - and foreign governments - to do it.
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