- Welcome once again as MIT Economics Professor, Paul Samuelson, discusses the current economic scene. This biweekly series was produced for Instructional Dynamics Incorporated and was recorded September 7, 1971. I'm just back from a quick trip to Europe. It was interesting to be in London, talk to people in the city in the aftermath of President Nixon's decisive action with respect to the dollar and with respect to his domestic programs. Of course what interested people abroad most was the behavior of the foreign exchange rates rather than what interested the man in the street in America most, namely the wage price freeze. Let me then give you some of the reactions that I encountered in talking to merchant bankers, to financial people, to economists, and in a limited degree, to the man in the English streets in Birmingham and in London. On the whole, President Nixon's program has been received, according to my samplings, very well abroad. I spoke to one merchant banker who confessed that he didn't understand why they were, they, the English financial community and the continental financial community, were not being more beastly about the President Nixon's program and he said the explanation that came to him was that everybody abroad had realized that the previous House of International Finance was a house of cards and that it was in a transitional state which could not last and so it was with a feeling of relief in a sense that the president's cutting off convertibility with gold had taken place. That then is the single most common reaction abroad. That, I think, cannot last. The knives are beginning to be sharpened and we are increasingly receiving criticism and will receive more criticism, I will predict, from people abroad because of what seems to them to be the unilateral character of the American policy. I should like to say that although I never hesitate to criticize the administration, and I never hesitate to criticize President Nixon when I think that his utterances are incorrect or ill advised or that his policies are not working. Still, I do not believe that I should feel critical of him in this regard. We know that there has been behind the scenes negotiation between our treasury officials and our fellow reserve officials for years now, suggesting to foreign governments, putting pressure upon foreign governments to our introducing some kind of flexibility in the foreign exchange set up. This is not something that Governor Dewey Daane of the Federal Reserve can go onto television to talk about. This is not something which, under secretary Paul Volcker, and both of these men I wish to point out represent continuity with the previous administration, they occupied essentially the same positions that they now hold in both the Johnson Administration, closing years of the Johnson Administration and in the Nixon Administration. They could not emphasize this, but you could read between the lines and in the lines, going way back to the Copenhagen Meetings of the International Monetary Fund and Bank and even earlier that the United States was pressing for a greater flexibility. We were imploring the Japanese to appreciate the Yen, in their interest as well as in our own and so, President Nixon really had no choice but to grasp the nettle himself. This raises the question of the 10% surcharge which President Nixon introduced along with his de facto suspension of the curtain vertability of official gold. In common with most economists, I have reservations about protective tariffs, about quotas, and about surcharges. I go along with the conventional wisdom, which says that depreciation of the dollar relative to other currencies provides the proper kind of protection which our industries need in a time when our currency is overvalued and that therefore it is redundant to also have a surcharge. I don't think that for the purposes of revenue alone a surcharge is very defensible in this modern age and it certainly is calculated to annoy foreigners. We economists should point out that a good deal of this annoyance is irrational. If they are not annoyed by the depreciation of the dollar, they should not be annoyed by a surcharge which has many of the same effects. None the less, they are annoyed. And yet, as I review the three weeks which have passed since President Nixon announced his program, it does become increasingly apparent that without the surcharge as a tactical weapon, the governments and central banks abroad would not have been even so cooperative as they have already been. Considering that the Japanese central bank, under instructions from the Japanese Government, has paid out more than four billion dollars worth of Yen to support the old parity of the Yen taking on that number of unnecessary dollars. We have to ask ourselves, how obtuse, how recalcitrant would they have been if there had not been the surcharge to shape them into reality. Very well then. The initial first couple of weeks' impact of the President's program has been on the whole, favorable. I did detect when I was in London something of a feeling of anticlimax because once the foreign exchange markets were reopened, once the dollar and all the currencies de facto began to float, it turned out that the dollar did not get itself depreciated very much, vis a vis, other currencies. The typical figure is three percent, four percent, five percent, depending upon whether we're talking about the pound or whether we're talking about the continental currency or whether we're talking about the Yen. Was all this bother worthwhile for so minuscule an amount of depreciation. You certainly have to be a besotted admirer of the classical mechanism of international exchange to think that pici-unis changes of this magnitude could compensate for a very large overvaluation of the dollar. Moreover, if we look at the German Mark, we have to realize that prior to President Nixon's action, it had already appreciated by about seven percent and although I haven't reviewed and checked with the very latest quotations, my impression is that the German Mark, as I speak, is at just about the same degree of appreciation vis a vis the dollar as it was before President Nixon's action. So we've had no further improvement along that front. A little wonder, then, that there is a sense of anticlimax around the world. It reminds me a bit of the phony war period in World War Two from the end of August 1939, beginning of September, when World War Two began with the Nazi invasion of Poland until the following spring, there was very little action. The French were under the illusion that the Maginot Line was holding and would hold and the German's having, by blitzkrieg, gone through Poland were gathering their strength for a blitzkrieg through Norway and the low countries. In the interval, it looked as if there wasn't very much of any warfare going on. That was, we now know, the calm before the storm. In a sense then, I think that we should not be misled by the moderation of the depreciations. The story is not yet over. I state that as a prediction, but I also state that as a pious wish because we have not yet had the amount of adjustment that is needed. It would seem, therefore, that one should form a judgment as to what's going to happen and what ought to happen by considering what economic principle, what economic analysis, economic theory tells us is needed to change the situation which had prevailed prior to President Nixon's actions of August 15th. For this purpose, let me quote freely from a small piece which I wrote for the London Sunday Telegraph in the immediate aftermath of the President's action. As I read this over a few weeks later, I have no particular cause to regret that I shot from the hip when asked by the editor to give my views and I should point out that having necessarily having to shoot from the hip without time to learn about what the administration's own views were, I certainly did not speak for the administration, I never speak for the administration. There are plenty of excellent economists who are called upon to speak for the administration and some of the things I said run contrary to some of the things which subsequently I heard the President's Press Secretary, state. Well, let me quote freely from this particular report. It's called The Dollar Crisis. I began by saying that although speculators can be blamed for the de facto suspension of convertibility, the evaluation if you like, the basic long run forces were that the dollar had given every sign of being overvalued currency for many many years and what set the speculators off was the news that our merchandise trade surplus, which equilibrium would have to be whoppingly positive and here I want to endorse the testimony of just the last week of an expert in international finance, Eduard Bernstein, very prominent consultant on international finance to many governments, formerly of the US Treasury, formerly of the International Monetary Fund. Although I had no knowledge of his position, specific position at that time, his views and mine turn out to be pretty, nearly the same. That what we need for equilibrium is a strong, positive surplus in our merchandise trade and a strong, positive surplus in our current balance overall. Perhaps something like seven billion dollars and of course, as the second quarter figures came out, it became apparent to everybody that we were not only very far from that number, but we were actually going into the red, into negative numbers for the first time since 1893. This inevitably, set the speculators noses to twitching and finally when the Royce Committee of Congress, so the Joint Economic Committee, came out with the flat-footed statement that the dollar was overvalued and that if necessary, there ought to be a revaluation, even a revaluation of official gold, the fact was in the fire. I said for the readers of The Sunday Telegraph that it would be instructive if I were now to dream some dreams, so here I begin. One, I said, the American dollar is to be lowered in value relative to SDRs, that is paper gold and official tier gold which incidentally must never again be confused with the free market gold of dentists, gangsters, and hoarders, and if this lowering of value of the dollar, this is a de facto and perhaps de jure devaluation with respect to paper and official tier gold, should be by the order of magnitude of say, 12%. That was a good, generous figure. I noticed that Dr. Bernstein doesn't go quite that far and although I didn't know it at the time, remember I was writing in the immediate aftermath of the crisis, Pierre Schweitzer, head of the International Monetary Fund, had also been leaking to the press the work of the experts in the International Monetary Fund who hoped for at least a small de facto and de jure official devaluation of gold. It was that leaked to the press which elicited from Mr Ziegler, the President's Press Secretary, denial that the administration had any intention whatsoever of changing the price of gold. That was point number one in my dream. Point number two, is the currencies of the surplus countries, most notably, Japan are not to change at all with respect to official gold. Hence, the deficit-ridden American dollar would thereby be depreciated by at least 12%, relative to the currencies of the surplus countries. Three, what about Canada and the various New World currencies that form the American block? It would be presumed that these American block currencies would go all or most of the way the the revalued dollar. That is, they would be devalued with respect to official tier gold by 10 or 12%. This leads us, finally, with lots of intermediate countries, countries such as Britain, which had neither so hard a currency as the Mark or the Yen, but not so soft a currency as the dollar and they might be expected to go about halfway, vis a vis official gold or that fraction of the way which the degree of strength of the balance of payments position of those countries would seem to warrant. I concluded my dream by saying, there is no need to make exact guesses and judgments in these initial resettings of parodies. For it is high time the world should move to a regime in which some flexibility of exchange rates is the standard feature. Whether this takes the form of crawling pegs or freely floating exchange rates or floating exchange rates subject to some intervention by the respective governments and central banks is not important. Well now, my purpose was not to dream impractical dreams, but I think that above dream tells us something about the direction the pragmatic reality should aim for. I went on to say, the first order of business is appreciation of the Yen and I must confess I could not believe the stubbornness of the Japanese Government, what seemed to be the willful ignorance. I've since learned that there are internal political reasons for that. These consist not simply of the understandable pressure from the export industries, from the shipping industries, many of which have contracts and dollars. For after all, any particular harm to those industries, which the government doesn't wish to happen could be compensated by subsidy. There now is talk of some aid programs to the victims of a Yen appreciation, but the more important reason is more ephemeral, namely that particular people in the Japanese Government, in the administration, who are jockeying for the succession to Prime Minister Sato, have gone out on a limb in this regard and so as long as they held power in the councils, they had a personal interest which I may say is divergent both from the national interest of Japan and from the international interest of the world to try ostrich-like to maintain the previous parody of the Yen relative to the dollar. Very well then. We'll suppose that the, that the Yen is appreciated by the amount roughly that I spoke of 10, 12, 15% one now begins to hear. The second order of business, I said, and now remember I'm writing for European audience is for all informed people abroad to realize that a depreciated dollar carries no threat of a massive invasion of European markets by American goods and services. I may say that I could only wish that such a massive invasion of European markets as a result of the kinds of exchange depreciates that I'm speaking of could possibly be feasibly in the cards. For if such a massive invasion were feasibly in the cards, it would enable us to restore equilibrium with a more moderate adjustment of parodies. Well, the sad truth is that it's not in the cards. At the same time that European intellectuals have been writing bestsellers on the challenge of the American leviathan, and have been bemused with America's competitive advantage in the realms of computers and aircraft, there are simple minds which cannot look beyond the two most dramatic aspects of our technology and civilization, namely computers and aircraft and forget how little these are in total importance relative to the total of goods in international trade and relative to the total of goods in the GNP. But while they were bemused with this American challenge, of course I have referenced to Servan-Schreiber's book on that, with that title. The statisticians have been recording a steady and almost unprecedented deterioration in the competitiveness of American industry. Take for example, our steel industry. Let no one think that a five percent or a 10% or even a 15% depreciation relative to the Yen and half that much depreciation relative to some other principle currencies would mean that American steel is gonna begin to land in European ports and Japanese ports and Australian ports. Our cost competitiveness is so far from being of the order of a 15% that that industry will still, I think, be screaming for protection and economists like me will still be objecting to favored treatment of such industries. Well, the dream world is over in which industry abroad could flood our markets and displace more American workers under the illusion that accepting return any amount of dollars, IOUs, if the process were generated, that this could go on. I had a letter from an old teacher of mine, Professor Hobueller, I had said some unkind words about the nine and neglect as ostrich-like policy which should have been forseeably understood not to be able to last and Professor Hobueller wrote that he had a clear conscious even though his pamphlet had used that title because what's the matter so long as the rest of the world will continue to send us goods for nothing. Why should we not accept them? And he went on to say in the teeth of the present crisis that the Japanese want to go on accepting dollars, that there was nothing wrong about, I'm not quoting him correctly and with full qualifications, the displacement of our industries by the Japanese imports. My answer was that this represented exactly the kind of thinking that I said was ostrich-like because it was unbelievable that the Japanese would in fact go on doing what they were doing in the first days of the crisis, namely buying for Yen any amount of dollars thrust to them at the previous parody. One must be realistic in making forecasts and that process cannot last and I would not disorganize any American industries in the expectation that we would have perpetual dumping of good Japanese goods on American consumers that would last and of course it has not lasted and would not last. Now, I dreamt a pleasant dream of the outcome. I may say that I don't wanna insist upon the details of it here, I have no particular brief for changing de facto or de jure the price of official gold, I just thought realistically that this was something which the Europeans would accept more readily and that it had none of the bad consequences or almost none of the bad consequences of the previous revaluations of gold before we had the two tier system, but let me in concluding say, that I also have a nightmare and that nightmare is that the world will turn into a chaos of exchange controls of trade wars and a tendency towards universal autarchy and already on my travels I have seen that there is an increase in the amount of exchange of controls. So, that although unilateral action by the President was necessary in grasping the nettle, in throwing the ball into the court of the Europeans and of the Japanese, we do not have unilateral power to introduce a nice state of flexible exchange rates near to the proper equilibrium parodies. We are in the same boat. There is a problem of persuasion here and the outcome is by no means optimistically clear. If you have any questions or comments for Professor Samuelson, address them to Instructional Dynamics Incorporated 166 East Superior Street Chicago, Illinois 60611.