Dodging the Falling Dollar
Scarcely a day goes by without new headlines on the decline of the dollar. In just the past 12 months it has dropped 16 percent against the Deutschemark, 20 percent against the yen, and 30 percent against the Swiss franc. In February the Saudi Arabian government shifted its monthly cash surplus of nearly $1 billion into Deutschemarks and Swiss francs; previously, 90 percent of Saudi cash had gone into dollars. Also in February, the 1975 IMF agreement that central banks would not buy gold expired—and some banks immediately began to buy. Newly released figures showed that the proportion of central bank reserves kept in non-dollar currencies had climbed from 7.5 percent in 1970 to 19 percent in 1976. (Nobody would hazard a guess what 1977's figures will show.) In March the Abu Dhabi newspaper Al Wahda urged the oil-producing Arab countries to abandon the dollar, demanding payment in a harder currency, in order to preserve their "national wealths." By the time you read this, the OPEC ministers may well have announced a decision tying the price of oil to a currency other than the dollar.
What is going on here? Why this headlong flight from the dollar? As usual, our political "leaders" and their lackeys in the media have done more to obscure than to explain the situation. "Oil imports!" they bleat in chorus. "If only we weren't sending $45 billion overseas to pay for Arab oil, the world would not be awash in unwanted dollars." But this conveniently jingoistic answer overlooks one crucial detail: why aren't Germany and Japan, which must import a far greater percentage of their oil, suffering similar currency problems? Why are their currencies, in fact, growing stronger month by month while ours continues to weaken?
The answer is really quite simple. The dollar is worth less and less abroad because it is worth less and less at home. The Arabs, the gnomes of Zurich, the money traders of Hong Kong, and their counterparts elsewhere are no fools. They understand that US inflation is destroying the value of the dollar. And what's more, they understand—even if the average TV-addicted American does not—that inflation is not caused by higher oil prices or coal industry wage settlements. Inflation is caused by government expansion of the money supply, to keep our politicians living beyond our means. It is no accident that "the Arabs have become rabid monetarists," as Business Week recently noted. "These Saudis and Kuwaitis watch the Thursday money supply figures every week."
The past few months have revealed some glimmers of understanding in Washington and the media. Time reports that public opinion polls, economists, and government economic policy makers are all agreed that inflation has become the nation's number one economic problem. But few have linked the dollar's travail to inflation, except the Wall Street Journal's Vermont Royster. In a recent column Royster alone asked the question nobody else would raise: "With the purchasing power of the dollar steadily declining in our own country, why should we expect foreigners to be eager to buy or hold them?"
What can we expect the Carter administration to do about the nation's number one economic problem? Precious little. In his first year in office, Carter and his Congressional majority gave us a costly new bureaucracy (the Department of Energy), a federal budget exceeding $500 billion, and a first-year deficit of over $50 billion. On this year's agenda are massive new farm subsidies, the beginnings of a national health insurance program, Congressional increases in the defense budget, and the Humphrey-Hawkins bill—all of which will likely push the federal deficit near the $100 billion mark this year. Financing that deficit, plus another $50 billion or so in borrowing by off-budget agencies, will soak up the majority of the nation's available capital—unless the Federal Reserve pumps out more money to keep the wheels turning. And that, of course, will stoke up still more inflation.
In the face of these realities, President Carter's "anti-inflation" plan—talking business and labor into moderating wage and price hikes, requiring inflation impact reports from federal agencies, slapping price controls on hospitals—would be laughable, if the subject weren't so serious. Yet that kind of pious hand-waving is all we're likely to get. Not slashes in government spending, not cuts in money creation, not large-scale tax cuts (which just might lead to reduced deficits by stimulating investments and employment), not a return to the discipline of a gold standard.
It isn't as if these were impossible dreams. Inflation in West Germany has been cut dramatically by modest doses of this sort of medicine—from 6 percent in 1975 to 3.9 percent in 1976 to as low as 1.8 percent in the last quarter of 1977. Inflation in Switzerland seldom exceeds 2 percent…in a bad year.
And the gold standard is staging a minor comeback in respectability, thanks to such works as Roy Jastram's The Golden Constant. That book chronicles the amazing 200-year price stability in England under the gold standard—and the 1148 percent inflation that has occurred there since it was abandoned in 1930. And when the Wall Street Journal calls for a return to the gold standard as the only way to end inflation (as associate editor Jude Wanniski did on March 15), it's a clear sign that things are looking up—at least in a few corners.
That's all well and good, you may say, but the Journal doesn't run the government. Those who do run it seem trapped by their political commitments into continuing inflation. In light of all this, what is the individual to do?
That is the question we addressed in preparing this fifth annual Special Financial Issue of REASON. As in past editions, one basic message comes through loud and clear: it's hard to go wrong if you bet on continued inflation. Hence, investments that protect your assets from the shrinking dollar—hard currencies, precious metals, gold and silver coins, real estate—find favor with our contributors. (Those, incidentally, are where many Japanese and Arab investors in the United States are putting their funds.) Also worth considering as a protective mechanism is the gold clause contract, explained in detail in this issue.
But it's also important to remember that inflation proceeds in cycles. At some point, the pressures to do something about inflation become so intense that meaningful action to curb money growth can be taken—for awhile—leading to periods of relatively less inflation. In such periods the dollar and the stock market tend to rise, while defensive investments like gold retrench. Unless your objectives are truly (and solely) long-term, single-minded concentration on hard-money investments will cause you to miss out on excellent opportunities in the stock market and other such investments, as Lloyd Clucas reminds us in his article.
To cope with inflation—to dodge the falling dollar—you must learn to discount most official explanations and pronouncements, while observing what is really going on and figuring out why. Helping you to do that is REASON's job—not just in this Special Financial Issue, but 12 months a year.
This article originally appeared in print under the headline "Dodging the Falling Dollar".