THE ECONOMY
The charge-sheet against Mr James Baker
JOCK BRUCE-GARDYNE
Mr James Baker, Ronnie Reagan's Treasury Secretary, has a lot to answer for. His crude attempts to 'talk down' the dollar in 1987, provoking the Japanese and Germans to try in vain to prop it up, contributed to the severity of 'melt-down Monday' last October, and his eagerness to keep the US economy roaring merrily away on behalf of his buddy George Bush's election campaign could now lead to pre- cisely the outcome he is keenest to avoid a secondary crash on Wall Street. But his greatest crime, surely, was the decision to turn the once-cloistered gatherings of the 'Group of Seven' top finance ministers into a regular circus for the world's financial press. Trying to keep tabs on the currency markets in an era of computerised global trading would be hard enough behind closed doors. Now that the Famous Seven are expected to reveal their views and plans to all and sundry at least once every six months it becomes positively counter- productive.
Last week they 'welcomed the additional evidence that the correction of external imbalances is under way'. Had they not been told that Uncle Sam's trade returns for the month of February, due out in less than 24 hours, and hence presumably on Mr Baker's desk, were going to provide evidence pointing in precisely the opposite direction? According to Mr Nigel Lawson they had not (and it is difficult to believe that they would have dared to put their signatures to such a piece of wishful thinking if they had been told what was in store). So either the Treasury Secretary was too busy with the Vice President's election campaign to read his dossiers, or else he saw fit to keep his guests in ignorance. Either it was behaviour of remarkable ineptitude, which could not have been better calculated to maximise the shock effect of the trade figures.
The great men took such comfort as they could from their success in containing the damage with the water-cannons of central bank intervention. 'The markets', said Mr Lawson soothingly, 'have settled down.... It is satisfactory.' So far. It's true that the Great Bear Trap sprung by the central bankers at the New Year, which nipped the fingers of the speculators against the dollar severely, is still fresh in dealers' minds, and therefore there is a lingering sense of caution. Yet, notwithstanding the latest alarms in the Persian Gulf, the dollar continues to look sickly, and there is ample reason why it should.
For steadying the markets in the im- mediate aftermath of the publication of the trade figures is reckoned to have cost $500 million, which is hardly chicken-feed for a single afternoon. Throughout 1987, it is now calculated, America's creditors added almost $140 billion to their US currency holdings: and the bulk of it accrued to the central banks, since the financial institu- tions proved reluctant to add to their existing dollar exposures. They — the central bankers — have now been warned by the International Monetary Fund that while the US trade deficit may, with luck, shrink to some $130 billion next year, further progress is not on the cards without some major, changes in policy. In other words, without increases in US taxes and interest rates, and reductions in federal government spending, designed to curb US consumption and lift the US savings ratio. President Bush may oblige (although he has sworn blind that he won't). Sufficient unto the day. What mesmerises the mar- kets is how we are to get from here to Inauguration Day.
If you are an optimist you say that the February trade figures were freakishly bad, just as the two preceding months had been freakishly good. You add, like Nigel Law- son, that the Federal Reserve Chairman, Alan Greenspan, will respond to the call of duty in good time by putting up US interest rates (it was 'far too soon' to do so on the basis of one month's trade returns, even though the Chancellor was telling the Americans to get on with it six months ago). You also privately reflect that the Japanese and German authorities, along with a host of bit players from London to Taiwan, will go on accumulating dollars regardless of the impact on inflationary pressures in their home markets, rather than stand by and watch the dollar vanishing from view.
If you are a pessimist you note that, in practice, even that most dedicated of born- again exchange rate managers, Mr Nigel Lawson, decided to call the Bank of England off and let the pound appreciate, rather than try to absorb surplus dollars like Dame Partington with her mop and pattens. You also note that Messrs Green- span and Baker offer no encouragment to our Chancellor's expectations of their sense of duty. Above all, you pore over the charts of 1930, and reflect that the second leg of the great inter-war bear market, which dragged the Dow Jones index steadi- ly.and inexorably down to vanishing point over the ensuing 18 months, began after a corresponding interval of recovery to the one which has now elapsed since 'melt- down Monday'.
At this point we are into the world of necromancy. Both the two essential ingre- dients in the secondary collapse of 1930-31 — protectionism, and the tightening of US monetary policy — are conspicuously ab- sent today. The leading protagonist of protectionism in the current US presiden- tial race, Congressman Gephardt, has just thrown in the sponge: and no one seriously doubts that if the latest trouble-spot in US domestic banking, in the state of Texas, shows signs of developing into something nasty, the Fed will ride in to the rescue.
Nevertheless, most of the major interna- tional financial markets, with the shining exception of Tokyo, are in a mood to shy at their own shadows. The panic reaction to the US trade figures for February was successfully restricted to Wall Street. If the figures for March are significantly better, then investors around the globe will breathe more freely. It is also possible that Messrs Baker and Greenspan will decide that the US economy is sufficiently buoyant to absorb an early interest rate hike without putting the Vice President's prospects of election to the White House at risk (given the condition of the Democrats, it is not obvious why they should hesitate, after all). But it doesn't look that way. And if instead the March figures turned out to be anything like as discouraging as those for February, then, in the absence of a pre-emptive strike on interest rates to tempt overseas investors back into the dollar, it is going to take more than CouOism from the Group of Seven to avert the sort of run on the US currency which would provoke a second Wall Street crash. In other words, you don't have to believe in the inevitability of a repetition of the Great Depression to fear that unless Secretary Baker shows a bit more savvy than he has to date, then the longest sustained period of expansion since the post-war recovery boom could come to a grinding halt.
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