Foreign-exchange whipsaws, the declining dollar, and the trade gap
Last winter Milton Glass, treasurer of the Gillette Company, faced a quandary. The Boston-based multinational corporation was anticipating a 1 million dividend in 90 days from its United Kingdom subsidiary. Gillette, with more than half of its sales abroad, has a leather-bound policy statement declaring, among other things, that it will not speculate in the foreign-exchange markets. It won't gamble on whether a currency will go up or down in value. To follow that policy strictly, Mr. Glass would have had to cancel any risk of the pound's dropping in value by hedging in the foreign-exchange futures market.
The pound, however, was extremely weak, selling for $1.03. Most forecasters were saying sterling was almost certain to rise.
Glass talked with fellow executives and decided on a compromise. He sold some of the pounds on the futures market right away and others later. When the dividend was paid, the pound was, as expected, worth more -- $1.48 to be exact. Glass got an average price of $1.32 on the futures market. It was, he concedes, a sizable ``opportunity loss,'' compared with what the dividend would have been worth in dollars if the parent company had not hedged at all.
This was a choice Mr. Glass would have preferred not to face. But with the volatility of exchange rates in recent years, many corporate financial officials face similar awkward decisions.
A new survey of 58 publicly owned companies by Boston's Shawmut Corporation finds that these corporations regard foreign-exchange risk management as more important to their financial results today than five years ago. They cite the strength of the dollar and the volatility of exchange rates as primary reasons for this change.
Of course, exchange rates are of far broader importance than the discomfort of corporate treasurers or harm to company profit levels. Most experts consider the super strength of the dollar to be the prime factor behind the massive US trade deficit and the resulting loss in jobs, particularly in manufacturing.
Indeed, this week the Subcommittee on International Trade, Investment, and Monetary Policy of the House Committee on Banking, Finance, and Urban Affairs approved legislation aimed at forcing the administration to manage the dollar further.
The administration has abandoned its former hands-off policy on the dollar. On Sept. 22, Treasury Secretary James A. Baker III agreed with his counterparts from West Germany, the United Kingdom, Japan, and France at a meeting in New York that the dollar was overvalued. In the six weeks following, the United States, Western Europe, and Japan sold some $10 billion to weaken the currency.
That is not a large amount relative to the volume traded on the foreign-exchange markets. Some $150 billion worth of foreign exchange is traded daily, according to a study by the Group of Thirty.
Nonetheless, the intervention of the major industrial nations has had sufficient psychological or marginal effect on the market to bring down the value of the dollar by about 10 percent on a trade-weighted basis since Sept. 22. It had already declined 10 percent from its high in late February of this year.
This, according to C. Fred Bergsten, director of the Institute for International Economics in Washington, is not enough. He calculates that the dollar must drop 20 percent more to bring the United States current-account position into reasonable balance.
This year the US current-account deficit, which includes the balance in merchandise trade, services such as tourism, and some capital flows, will run around $125 billion. US exports are only about 50 percent of imports.
So exports must grow twice as fast as imports to stop the deterioration in the trade account, notes Mr. Bergsten, a former high Treasury official. Further, the US is piling up external debts to finance the massive current-account deficit, and the interest on that growing debt compounds steadily.
Stephen Marris, of the same research institute as Bergsten, calculates that, given the present exchange rate of the dollar, the US current-account deficit will mount to $200 billion by 1990.
That size deficit is probably politically unbearable. The US would likely take major protectionist measures to slow imports.
Worried by the massive deficit, the House Banking Committee will consider today its subcommittee's foreign-exchange measure. The bill, proposed by New York Rep. John J. LaFalce (D), requires the President to set up an advisory commission on exchange-rate reform, to enter into international negotiations to reform the rate system, and to create an institutional system for intervention in the foreign-exchange markets to force the dollar to a competitive level. The bill would also insist that the secretary
of the Treasury report to Congress twice a year on foreign-exchange issues, much as the Federal Reserve Board chairman must do on monetary policy.
Bergsten holds that intervention in the exchange markets and manipulation of international capital flows is an unfortunate but necessary means for weakening the dollar and thereby decreasing protectionist pressures. His preferred solution to the problem, however, would be greater international harmonization of domestic economic policies. At the moment, that would mean a smaller budget deficit and lower interest rates in the US, and government efforts in Japan and West Germany to stimulate domestic grow th.
Achieving such harmonization, he acknowledges, will not be easy.