The Dollar in Trouble Overseas
“APPRECIATION has apparently grown over how close to an economic disaster the Capitalist nations have moved.”
That conclusion came from a group of the Western world’s most distinguished economists meeting in Italy. The report, published by the New York Times, added that “something is seriously wrong with the international monetary system.”
Why such a gloomy outlook for the Western world’s finances? The main cause is the United States dollar. It is in deep trouble overseas. “The U.S. dollar, contrary to popular belief, is about as sick as ever,” said U.S. News & World Report.
There was a time when the American dollar was greatly prized. Individuals and governments in other lands were happy to have large holdings of them. That is no longer the case.
Spending More than Income
Why has this situation come about? To illustrate: suppose you had a job that paid you $1,000 every week. Would you say that you were well off financially? Most people certainly would say so.
However, what if you spent $1,100 every week during the year? What if you spent $1,200 every week next year? What if you continued spending more than your income year after year? Simple mathematics would tell you that, after you used up any savings you had, you would be going deep into debt.
After a while, banks and credit firms would realize that you were living too far beyond your means and that you were a poor risk. They would see that you were headed for bankruptcy and would stop lending you money.
Thus, regardless of what income a person has, he certainly is not well off if he continues to spend more than he makes. That is not the way to prosperity. It is the way to go broke. To avoid bankruptcy, unless it is too late, he has to change his way of living. He must get his spending in line with his income.
Nor does it matter if he makes $100 a week, $1,000 a week, or $1,000,000 a week. What is crucial is how much he spends. If he keeps spending more than he makes, he will eventually get into trouble.
Although the matter of international finance is far more complex, basically that is what has happened to the United States. It has been spending more money in foreign countries than it has been earning there. Hence, in its international transactions the United States is going broke at present.
To appreciate better why this is so, it would be helpful to see what system many of the nations outside the Communist bloc have established to settle their international accounts.
The Western Financial System
Within any one country, the local currency is used when buying or selling. For example, a citizen of France goes to the store and buys goods. He pays for them in French francs. He knows what his currency can buy at any given time.
But what happens if that French citizen wants to buy an American-made automobile? How many francs must he pay for the dollars that the automobile costs? There must be some international system that lets governments, businesses and individuals know what their money is worth in relation to the currencies of other countries.
Governments could just let the value of their money rise and fall in international transactions depending upon the law of supply and demand, that is, how much their currency is valued by other countries. But that would result in a constant fluctuation in the relative values of currency. Sometimes the fluctuation would be very large.
Such a system would make it difficult to carry on world trade. Businessmen want to know what it will cost them to buy or sell goods abroad over a period of time. They must know how much of another country’s currency their own money will buy. In this way they can determine what to charge for their products.
So a stable rate of exchange is most desirable for world trade. And such a system was agreed upon by members of the International Monetary Fund. This Fund is made up of more than 100 nations outside the Communist bloc, and was established at a conference in Bretton Woods, New Hampshire, in 1944. It arranged for cooperation between nations on international money problems. The members also agreed not to let their currencies fluctuate more than 1 percent higher or lower than the established values.
Dollar ‘Good as Gold’
The Fund members agreed on the principle that the value of each nation’s currency would be based on its relationship to the United States dollar. The dollar, because of America’s financial and industrial strength, was the strongest currency at the time.
It was also agreed that the dollar would be acceptable as a form of reserves in any of these countries. And what would back up the paper dollars? Gold. Any nation holding dollars could turn them back to the United States and get gold for them at the established price of $35 an ounce.
Gold has always had intrinsic value. Unlike paper money, gold is always in demand for use in industry, jewelry, art and otherwise. So if one nation of the Fund began to accumulate too many dollars, it could turn them back to the United States and get gold instead. Yes, the dollar was ‘as good as gold.’
Because of this system, when an American businessman bought a machine from Germany, he knew in advance what the dollar was worth in German marks. And the German knew he could either hold on to the dollar, spend it to buy an American product, exchange it for some other currency, or turn it back and get gold. All of this facilitated world trade.
But why must nations have to trade and go through all this? Because different countries produce some items more economically than they do other items. They can use these things to obtain goods they do not produce at all, or cannot produce efficiently.
For instance, Japan sells many items, such as automobiles, television sets and radios, to other nations. It uses some of the money it makes from these sales to buy oil from the Middle East. Why oil? Because Japan does not produce any oil to speak of. Without oil, her industry would grind to a halt. So she sells what she produces well and uses the money to buy what she does not produce well.
The system agreed upon in 1944 works as long as nations spend about the same amount as they make. It is like the person who makes $1,000 a week. He may spend somewhat more this week, but somewhat less next week. Over a period of time, he has no problem if he balances his accounts, spending about what he makes.
However, when he habitually spends more than he makes, then he is headed for trouble. When a nation does the same in world trade, it also is headed for trouble.
In 1950, due to United States spending in other countries, foreigners held about 8.6 thousand million American dollars. But that was no problem. The United States had about 22.8 thousand million dollars in gold to back that up, a huge surplus. Anytime the other countries wanted, they could turn their dollars back and get gold. Yes, in 1950 the dollar was still ‘as good as gold.’
However, ten years later, in 1960, that gold surplus had disappeared! Foreign dollar holdings totaled more than the gold possessed by the United States. And by 1970, the situation had grown much worse. According to one estimate, foreigners held over 43 thousand million dollars, but the United States had only a little over 11 thousand million in gold. It owed foreigners about four times as much as it had the ability to pay!
Nor was the situation improving. In fact, 1970 saw the largest imbalance yet. In just that one year, the United States ran up a startling 10 thousand million dollar deficit in all its overseas transactions. And in just the first three months of 1971 the deficit totaled a staggering 5.5 thousand million dollars!
What would happen now if other nations demanded gold for all their dollars? Newsweek answers: “The United States would almost surely close the window, throwing the international monetary system . . . into a period of confusion. And it is at this point that the wonderland of international finance touches daily life: the result of such chaos might be a world depression similar to the slump of the 1930s.”
[Graph on page 5]
(For fully formatted text, see publication)
(Figures represent billions of dollars.)
FOREIGN DOLLAR CLAIMS
U.S. GOLD RESERVES
1950 1955 1960 1965 1970