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The sustained and alarming depreciation of the U.S. dollar against some major European currencies and the Japanese yen during 1977 and the early part of 1978 has ushered in a new element of instability in the shaky international monetary system. One of the most critical effects of the dollar devaluation has been a new and unwelcome pressure on the real price of crude oil, which has been steadily shrinking since 1973 (despite the two 10-percent-upward adjustments in October 1975 and December 1976).
Columnists and economic prognosticators have been wondering how long the members of the Organization of Petroleum Exporting Countries (OPEC) are going to tolerate continued declines in the exchange value of their substantial oil export earnings, and acquiesce in the erosion of their dollar-denominated assets. The jitters about OPEC's possible counteractions have been triggered by a series of statements and warnings by OPEC officials regarding the dollar's 1977 performance and its rather uncertain future. Cabinet ministers from Iraq, Indonesia, Kuwait, the United Arab Emirates and Venezuela have expressed their concern publicly, and have formally asked their fellow OPEC members to take concrete actions to stop revenue losses. Even the Iranians and the Saudis, who seem to have considered the dollar's fall as temporary (and a decision on changing the methods of oil pricing or oil payments as premature), have reportedly been nervous about their ability to hold the line against the oil price rise, if the dollar should continue to decline.
OPEC's worries about the continued erosion of its purchasing power, and the market's fears about the oil exporters' reactions, have been both serious and real. Between January 1977 (when the crude oil price was last raised) and April 1978 (when the dollar showed faint signs of stabilization), the U.S. currency depreciated by more than 22 percent against the Swiss franc, 21.5 percent against the Japanese yen, nearly 14 percent against the deutsche mark, 10 percent against the pound sterling, some 6 percent against the French franc, and even a small 3 percent vis-à-vis the Italian lira. While the decline of the U.S. dollar over a 21-month period, weighted in terms of U.S. trade, was much less than these figures might indicate1 - actually, only 7.5 percent - the damaging impact on OPEC as a whole, and particularly on some of its members, was considerable.
Due to differences in individual countries' trade direction and reserves composition, actual losses resulting from the dollar depreciation are not easy to assess. These losses obviously loom substantially large for those OPEC members (e.g., Algeria, Iran, Iraq, Indonesia, Kuwait and Nigeria) that purchase more than 70 percent of their import needs in the West European and Japanese markets, and for those (e.g., Saudi Arabia, Kuwait, and some other Persian Gulf oil exporters) that hold the bulk of their accumulated reserves in U.S. securities and dollar accounts. For a country like Venezuela, which has some 60 percent of its trade with the United States, and also keeps much of its multibillion dollar reserves in dollar-denominated assets, the picture is mixed: exchange losses in foreign trade are less pronounced in comparison with, say, Iraq or Libya; but the erosion of purchasing power of dollar balances is more substantial.
For OPEC as a whole, the outcome would depend on the duration of the dollar downswing, the currencies against which the depreciation is measured, the weight of such currencies in a basket, and other trade-related factors. Thus, in terms of the value of Special Drawing Rights (in which the U.S. dollar itself has a 33 percent weight) the depreciation of the U.S. currency between January 1977 and April 1978 was about seven percent. Measured against the arithmetic average change in the dollar value in terms of the 11 currencies under the so-called Geneva II formula,2 the dollar's loss of value was more than ten percent. And the average decline (trade-weighted in terms of OPEC's imports from the 11 countries concerned) would give a figure of nearly 18 percent.
Taking a half-way figure of 12.5 percent between the SDR-based depreciation of seven percent and the trade-weighted Geneva II estimate of 18 percent, the order of magnitude of OPEC losses during the December 1976-April 1978 period can be conservatively put at about $15 billion. To this figure should be added the loss of buying power of OPEC's estimated $70 billion in liquid reserves, and of some $80 billion in foreign placements (half of which is reportedly kept in dollar deposits and dollar assets).3
The most talked-about schemes for OPEC to deal with dollar depreciation are (a) a new hike in the price of oil to compensate for the dollar's fall - proposed by Iraq, Kuwait and Venezuela, and supported in principle by Indonesia; and (b) a switch from the dollar to a currency basket, or currency cocktail for the purpose of oil-pricing policy - advocated by Iraq, Qatar and the United Arab Emirates, and supported by Venezuela.
The call for a new oil price rise during the remainder of 1978 is rooted in the argument that the continued deterioration of the dollar value has "absolved" OPEC members of their commitment to a temporary price freeze made in the Ministerial Conference at Caracas in December 1977. Members are thus free to vote for a price rise. The wisdom and practicality of such a move, however, has been the subject of considerable speculation in and out of OPEC circles. The soothsayers are widely divided this time. Some analysts believe an oil price hike of 5-10 percent, beginning July 1, 1978, "likely" - due to the expected rise in the West European demand for oil, and OPEC's downward output adjustment to reduce the existing "glut." Others, taking a gloomier view of a significant world economic upturn this year and next, predict the continuation of a soft market for oil and the need for a steady oil price until mid-1979 and perhaps through 1980.
Judging by the statements of the two largest exporters so far, the oil price freeze is likely to continue for the balance of this year unless Western economies recover sufficiently (and the demand for oil increases correspondingly) - or, alternatively, unless the U.S. dollar maintains its downward slide. This view seems to have prevailed in the informal meeting of OPEC oil ministers in Taif, Saudi Arabia, on May 7, 1978.
Another suggested scheme to make up for dollar depreciation would be a shift to a basket of currencies as the basis for pricing crude oil. In the OPEC ministers' summer meeting in Gabon in June 1975 (when the U.S. dollar had again been on a slide for the previous several months) a switch to Special Drawing Rights (SDR) was discussed, but no firm decision was taken. Subsequent recovery of the U.S. currency against the SDR and other major currencies obviated the need for further action.
The interest in a multi-currency basket as the basis for oil pricing was revived in mid-1976 when the U.S. dollar began its second protracted depreciation vis-à-vis the SDR and the currencies of major industrial countries. Early in 1978, the Oil Minister of the United Arab Emirates publicly called for the substitution of a new basket of currencies for the U.S. dollar as the pricing unit.4 Other proposals so far widely discussed have had to do with (1) a revised SDR basket in which the U.S. dollar would have a smaller weight, or would be eliminated (along with OPEC currencies) in favor of the Swiss franc; (2) a renewed Geneva II basket; and (3) a four- or five-currency basket comprising the mark, yen, French franc, pound sterling, and Swiss franc.
The shift to a currency basket, regardless of its composition and relative weights, is a complicated and not altogether riskless undertaking. It may reduce exchange risks, but cannot eliminate them; and it is subject to the inevitable disadvantage of "symmetry." Oil pricing in terms of the SDR would benefit the oil exporters by (a) reducing fluctuations in oil earnings in terms of domestic currencies; (b) increasing stability of petroleum revenues relative to import expenditures from non-"hard currency" sources, which currently account for more than 55 percent of OPEC imports; and (c) enhancing OPEC's bargaining position vis-à-vis the major oil companies by cutting the exchange risks that the latter must bear or hedge against because OPEC oil is paid for in U.S. dollars, but is sold in world markets in a mix of currencies. Other baskets may also be similarly attractive from the standpoint of OPEC interests.5
But, from the vantage point of protecting the purchasing power of oil revenues, the SDR, like any multi-currency basket, is a double-edged sword. As long as the U.S. dollar weakens in world markets, a barrel of crude oil priced at so many SDRs would naturally fetch more dollars, and larger dollar payments to the oil exporters. But, if the dollar should recover from its recent low points (as it did shortly after the 1975 Gabon meeting) OPEC would face sizable exchange losses. That is, if - as is now widely surmised - the dollar's long ordeals should be over, and its value should begin to rise in terms of both the SDR and other hard currencies, then a switch to the SDR basket at this time would be sheer financial folly for OPEC (as it was in June 1975).6 OPEC would not receive its full share out of the dollar's upturn, and smaller dollar payments for the same volume of oil exports would be obtained. Only if one were to be sure that the U.S. currency would begin to falter again, after its temporary stabilization, would a shift to the SDR (or any other currency cocktail) be financially rewarding. Timing is of crucial significance. So is crystal-ball knowledge about the U.S. medium-term external balance of payments.
Short of perfect timing, what OPEC can do with the SDR (or for that matter, any other basket) is to "backdate" the effective date of its switch from the dollar - a proposal that was vaguely contemplated in Gabon. That would mean choosing a date when the U.S. currency had its highest value in terms of the SDR in the last 22 months (e.g., June 1976). But such an action at this time would unequivocally mean raising the price of oil by about eight percent. And this is a measure that has so far strongly been disfavored by the two largest oil exporters.
Another option would be the adoption of an "asymmetrical" SDR basket (which was originally considered but not adopted by the International Monetary Fund). In this method of valuation, the SDR would only reflect the appreciations of its embodied currencies but not their depreciations.7 A third possible alternative would be to add a safety net to the SDR pricing by providing a "floor price" for the marker crude expressed in dollars so as to offset any future SDR depreciation against the U.S. currency. A fourth possibility would be the adoption of the SDR not only as a denominator for pricing crude oil, but also as a numerator for payment of oil revenues. In this case, oil exporters would receive payments in the actual currencies included in the basket in proportion to their fixed quantities - thus ensuring the stability of oil receipts regardless of exchange movements. But since not all the 16 currencies in the current SDR basket are readily available to the oil companies, nor needed by the oil exporters, a series of purchases and sales would have to be made in exchange markets (at substantial commission costs to the companies and countries alike) to convert unneeded currencies into desired ones.
Any one of these schemes, however, in addition to their inherent price-raising character at this time, entails some purely psychological effects on exchange markets. In general, any change of the oil-pricing formula away from the dollar when the dollar is weak is likely to further erode world confidence in the U.S. currency and to add to its downward pressures.8 The dollar's plunge following the switch may help boost oil exporters' receipts from immediate oil shipments; but it would also further depreciate their huge dollar balances, and would thus certainly be resisted by surplus members. This is perhaps a major reason why Saudi Arabia has so far objected to any switch from the existing dollar system.
The implications of a widely fluctuating, and shrinking, dollar are not only of vital concern to OPEC members, but are of serious portent to the viability and efficiency of the international monetary system. World public opinion often closely relates a country's political leadership, economic power and administrative resolve with the strength of its currency. The drop in dollar value aggravates U.S. inflation and has a rather slow beneficial effect on America's balance of trade. The weak dollar also encourages the flight of capital from the United States, and slows down U.S. private domestic investments. For not altogether clear reasons, the sick dollar also depresses the U.S. stock market. And, above all, a failing dollar upsets the whole fragile fabric of the present international monetary system.
Under the recently amended Articles of Agreement of the International Monetary Fund, every country is free to choose its own exchange arrangements, i.e., to peg its monetary unit to another member's currency, or to a basket of currencies of its own choosing, or to the SDR; or not to peg, and to follow other procedures - subject only to an overall "surveillance" by the IMF.9 Under this system each member agrees to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates.
Such a system may be sustainable under certain provisions, but its overall stability cannot be assured. With gold out of the system, and the SDR not yet firmly in place, the present order is in practice a dollar standard under which the United States shares the control of world liquidity with some other major currency centers, the international private banking community, and the IMF. A tolerably satisfactory functioning of the system would therefore hinge upon extensive central bank and intergovernmental cooperation along with certain supranational supervision of the Eurocurrency market through the IMF. The system is likely to be crisis-prone in the absence of multilateral surveillance.
Under these circumstances, where major industrial countries (especially the so-called locomotive countries) pursue largely inward-oriented and politically easy domestic economic policies, no one can be indifferent to how one's exchange rate moves, and everyone is increasingly disposed to regard the currency rate as an instrument of policy. Thus, to the extent that major trading countries follow widely divergent growth, employment, price and budgetary policies at home, any fixed exchange rate system - whether by regions, hemispheres or large economic blocs - would be subject to violent twists and turns; it would also be highly prone to economic warfare in the form of competitive exchange depreciation, trade restrictions and beggar-my-neighbor policies.
With no firm commitment on the part of industrial countries to coordinate their employment and price policies, a return to a system of "fixed but adjustable" par values (while widely desirable) would thus be highly impractical. And, with several hundred billions of the so-called footloose dollars floating in the world exchange markets, exchange fluctuations could still be expectedly large, and short-term capital movements destabilizing. Meanwhile, businessmen's attempts to deal with the situation through forward exchange contracts, long-term private currency swaps, and a judicious use of the capital market, and the governments' attempts to underwrite exchange risk insurance, are at best no more than stopgaps.
As long as these conditions prevail, an OPEC shift to the SDR may be only a second or third best alternative - short of full indexation for inflation in the major oil-consuming countries, and full compensation for exchange depreciation. The most desirable arrangement would naturally be periodic price adjustments in response to world demand and supply of oil and exchange rate movements. But for these adjustments to be smooth, gradual and absorbable, the dollar rate vis-à-vis major world currencies should remain pretty stable and predictable.
The dollar's stability, in turn, would depend on removing the root causes of world monetary imbalances. By any measure, the U.S. dollar is the world's most outstanding currency due to the sheer size of the U.S. economy, and also because the dollar is now virtually the international system's main means of payment and its principal reserve asset (i.e., nearly 65 percent of total world reserves). On account of its colossal magnitude and far-flung exposure (and also because the dollar is largely free from the financial discipline imposed on other world currencies), even a relatively small shift out of Eurodollars defies ordinary central bank interventions. Diversification moves, away from the dollar, occur by and large whenever speculators consider the U.S. external position vulnerable. This vulnerability, in turn, is the mirror of America's underlying economic conditions, e.g., the rate of domestic inflation, the size of the budget gap, the deficits in the balance of trade and payments, the cyclical trend of the economy, and above all the structural competitiveness of U.S. industries.
The 1976-78 "dollar debacle" is chiefly attributed to the U.S. huge oil imports ($45 billion in 1977), balance-of-trade gap ($29 billion), and balance-of-payments deficit ($20 billion). Actually it has been the product of a complex set of factors: a faster U.S. growth rate compared to its main trading partners; two mammoth budgetary deficits ($60 billion each) in 1977 and 1978; phenomenal increases in the trade surpluses of Japan and Germany (both, ironically, more dependent on foreign oil than the United States); the specter of another round of domestic inflation in the American economy in 1978; and a growing worldwide lack of confidence in the dollar's future - based on the real or imaginary belief that the United States is neither willing nor able to stem the dollar's fall.
Under these circumstances, the short-term classical remedies have called for import restrictions, exchange control, barriers against capital outflows, and the adoption of general deflationary measures (including higher domestic interest rates in addition to currency devaluation). But this is precisely where the U.S. Administration has faced its Catch-22. Currency and capital controls would be ineffective because of the amount of Eurodollars beyond the U.S. reach. They are likely to further weaken confidence in the dollar. Import restrictions (or export subsidies) would be similarly self-defeating because they would invite retaliation by injured partners. High interest rates and slower economic growth at home would increase politically sensitive domestic unemployment, and could also trigger another worldwide recession. Only a sharp cut in oil imports could provide a quick effective cure for the dollar. But this move (in addition to upsetting the oil production pattern in OPEC economies) would require either domestic fuel rationing or steeply higher fuel prices - both of which are politically unpalatable.
Faced with these unhappy choices, a host of other suggestions have been offered by economists and businessmen to prop up the ailing dollar. These measures have included the sale by the U.S. Treasury of foreign-currency-denominated bonds in order to engage in more aggressive market interventions; larger currency swap arrangements with foreign central banks; the use of IMF credit; and the sale of Treasury gold in the open market. Supplementing these "quick-fire" actions have been suggestions regarding the need for: the passage of an effective U.S. energy conservation and production program; a convincing anti-inflation policy; new tax and welfare policies that could reduce unemployment through increased business investment instead of public work programs; and innovative measures to improve dwindling American competitiveness in some key industries.
Most of these measures are supported by the Carter Administration, and some of them, (e.g., doubling swap arrangements with Germany, the use of SDRs to buy foreign currencies, the decision to sell a small part of U.S. gold reserves, and a new anti-inflation declaration) have already been adopted. The fate of the tax and energy bills in the Congress may now be somewhat brighter than before. But the dollar is by no means out of the woods. And the only lasting and effective remedy would seem to be the restoration of world confidence in the future growth and strength of the U.S. economy, and in U.S. determination to defend the dollar's value. Short of this confidence - which takes time, and very persuasive measures by the U.S. government - the intervention facilities at the United States' disposal would be too meager, and too weak to do the job.10
The immediate measures that are likely to enhance world confidence in the dollar would seem to be the United States' continued pursuit of free trade and exchange policies; determined market intervention to smooth out "disorderly" currency rates; allowing other major currencies to serve as reserves along with the dollar; increasing U.S. capability for market intervention as a kind of psychological underpinning of the dollar support policy; and, above all, a clear turnabout of the inflationary forces in the U.S. economy.
In the long run, however, the only real hope for dollar stability - and OPEC's cooperative attitude - would be in (a) enhanced coordination of policies among the major industrial countries to ensure orderly noninflationary growth under free market conditions; and (b) an accommodative arrangement between OPEC and major oil consumers with respect to oil revenues and protection of the dollar's purchasing power.
Essential to the establishment of a stable international monetary system under which these requirements could be met would be the realization of the inexorable interdependence of national currencies and national monetary policies. An integrated worldwide capital market exists today beyond the control of any one nation or monetary authority. In the present world monetary system, no national monetary and credit policy can avoid having far-reaching repercussions on exchange rates; and no exchange rate policy can leave domestic money and credit decisions alone. The relationships would differ under a par value system compared to a system of floating exchange rates. But the interdependence is inescapable.
The solution to world monetary instability thus lies not so much in the choice of a particular exchange system - whether fixed or floating - but in the coordinated determination by major economic powers to make the system work, that is, to pursue cohesive and complementary fiscal and monetary policies designed to ensure noninflationary growth everywhere. In the guarded language of the Tenth Interim Committee of the IMF, meeting in Mexico City on April 30, 1978: "improvement in basic underlying conditions" is a contributor to "greater stability of exchange markets," and such stability in turn is considered "extremely important for the health of the world economy."
The pursuit of such common objectives would of course necessitate some sacrifice of national sovereignty through the coordination of domestic money and tax policies. But if this political feat could be achieved, the technical and mechanical aspects of coordination could be easily worked out. Without it, today may be the bad day for the dollar; but tomorrow when the U.S. currency is no longer under attack, it may be the turn of the pound, the Italian lira, the French franc - and, who knows, maybe even the mighty mark.
1 Over the same period, the U.S. dollar appreciated against a number of other currencies, such as the Canadian dollar, Swedish kroner, Spanish peseta and Israeli pound, among others. Of these, Canada in particular had a large share of U.S. trade. But these countries had no significant share in OPEC's bilateral trade.
2 An agreement reached between OPEC and major oil companies in Geneva on June 1, 1973 called for an adjustment of the posted price of marker crude in the Persian Gulf in terms of the arithmetic average of changes in the value of the U.S. dollar vis-à-vis the Australian dollar, Belgian franc, Canadian dollar, French franc, deutsche mark, Italian lira, Japanese yen, Dutch guilder, Swedish kroner, Swiss franc, and pound sterling.
3 If the higher costs of industrial imports by OPEC members were to be added to the loss of purchasing power, the combined loss is estimated to have reached 23 percent in one year. By one estimate, the value of a barrel of crude oil to OPEC members in terms of their combined 1974 import price index was in the neighborhood of only $5 compared to the nominal price of $12.70.
4 Some 70 percent of the new basket was to be comprised of traditional hard currencies such as the dollar, mark, sterling, yen, and Swiss and French francs; 20 percent would be made up of OPEC currencies such as the Saudi riyal, Kuwaiti dinar, etc.; and the remaining 10 percent would be expressed in gold.
5 The SDR basket has certain clear advantages over other baskets in that it is internationally recognized, multinationally controlled, and with currencies that are probably as nearly representative of OPEC's imports (although not in exact weighting) as any special import basket that OPEC members may desire.
6 Had the SDR been adopted in June 1975 at the then-prevailing SDR-dollar rate, other things remaining the same, the cumulative OPEC losses up to March 1978, it is estimated, would have been between $20 billion and $27 billion, depending on methods of calculation. These figures, of course, presuppose that an OPEC decision to peg to the SDR would not have had by itself any effect on the market value of the dollar - a not very plausible assumption.
8 For this reason, the U.S. Treasury has opposed any shift by OPEC from the dollar pricing.
9 As of April 30, 1978, some 67 IMF members pegged to a single currency (44 to the U.S. dollar, 14 to the French franc, 5 to the pound sterling, and 4 to other monies). Some 31 countries pegged to a composite basket of currencies; 21 were regarded as "floating"; and the remaining 14 countries followed other arrangements.
10 U.S. total currency swap capabilities reportedly are about $20 billion; its likely use of the IMF resources no more than $5 billion; and the total value of its 277 million ounces of gold at current market prices, near $50 billion - not all of which can be sold at the market price without sharply reducing it. Against these limited assets loom some $500 billion of liquid dollar assets owned by outsiders, part of which is daily floated in the market and hard to "manage" if the volume of daily transactions is large.