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Defending the Dollar?
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14140 |
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Section : |
CURRENT ISSUES
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| Issue
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1 / 1988 |
823 Words |
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Warren T. Brookes
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President Reagan told last fall's International Monetary Fund conference that the United States had done its part in defending the dollar by signing the new Gramm-Rudman-Hollings deficit reduction law on the heels of a $65 billion deficit reduction in fiscal 1987.
Yet one of the ironic effects of that new law, and of deficit reduction itself, could be to undermine confidence in the dollar further by weakening America's defense posture.
Indeed, even as the budget deficit has plunged from $221 billion to $155 billion, the dollar has weakened still more. This contradicts the conventional thesis that the 76 percent rise in the dollar from 1980 to 1985 was "caused" by budget deficits.
Besides, one has to ask, how can a "weak fiscal policy" produce a "strong dollar," and why should a "strong fiscal policy" (that is, bringing deficits down) "weaken" the dollar?
The plain truth is this: A strong currently has always signaled national strength, not weakness--and at least some economists think there is a direct connection between defense spending (as a surrogate for national will and resolve) and the dollar.
In December 1985 I published some charts showing the remarkable "coincidence" between trends in the U.S. defense budget and trends in the dollar. This was suggested by Professor David Fand, a nationally known monetary economist from Detroit's Wayne State University.
The columns inspired Robert Ayanian, an economist at California State University in Fullerton, to study this relationship more carefully, and his results are to be published in the scholarly journal Economic Inquiry, published in Huntington Beach, California, by the Western Economic Association.
Ayanian finds that "there is a strong positive correlation between the Federal Reserve's trade-weighted real exchange rate index and the U.S. defense budget share of gross national product."
His paper will present a chart showing that, since the birth of the floating exchange rate regime in 1973, the dollar has fallen and risen almost precisely as the U.S. defense spending share of GNP has fallen and risen. Its biggest fall coincided with the Carter administration's 1976-79 defense slashing; its biggest rise coincided with the Carter-Reagan 1980-85 defense buildup.
Ayanian argues that "the political risk associated with holding wealth in the United States varies inversely with U.S. military security, and, due to the Soviet military threat to the West, is a major element in foreign asset demand functions."
In other words, investors seek a "safe haven" for their money. Ayanian says while "there is a long list of candidate variables [to explain the dollar's fluctuations] … the lack of consensus … reflects the poor statistical performance of most of these theories."
He also found "the political safe haven hypothesis has not been subjected to the same careful consideration afforded the more
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