The Frontiers of Management. Peter F. Drucker

Indeed, they try to convert the dollars they hold into other currencies. The resulting “flight from the dollar” brings the dollar's exchange rates crashing down. It also creates an extreme credit crunch, if not a “liquidity crisis,” in the United States. The only question is whether the result will be a deflationary depression in the United States, a renewed outbreak of severe inflation, or, the most dreaded affliction, stagflation, that is, both a deflationary, stagnant economy and an inflationary currency.

      There is, however, also a totally different “hard-landing” scenario, one in which it is Japan rather than the United States that faces a hard—a very hard—landing. For the first time in peacetime history the major debtor, the United States, owes its foreign debt in its own currency. To get out of its debt it does not need to repudiate, to declare a moratorium, or to negotiate a rollover. All it has to do is to devalue its currency, and the foreign creditor has effectively been expropriated.

      For foreign creditor read Japan. The Japanese by now hold about half of the dollars the United States owes foreigners. In addition, practically all their other claims on the outside world are in dollars, largely because the Japanese have so far resisted all attempts to make the yen an international trading currency lest the government lose control over it. Altogether, the Japanese banks now hold more international assets than do the banks of any other country, including the United States. And practically all these assets are in U.S. dollars—640 billions of them! A devaluation of the U.S. dollar thus falls most heavily on the Japanese and immediately expropriates them.

      But also, the Japanese might be the main sufferers of a hard landing in their trade and their domestic economy. By far the largest part of Japan's exports go to the United States. If there is a hard landing, the United States might well turn protectionist almost overnight; it is unlikely that we would let in large volumes of imported goods were our unemployment rate to soar. But this would immediately cause severe unemployment in Tokyo and Nagoya and Hiroshima and might indeed set off a true depression in Japan.

      There is still another hard-landing scenario. In it neither the United States nor Japan—nor the industrial economies altogether—experiences the hard landing; this will be suffered by the already depressed primary-products producers. Practically all primary materials are traded in dollars; thus, their prices may not go up at all should the dollar be devalued. They actually went down when the dollar plunged by 30 percent between June 1985 and January 1986. Japan may thus be practically unaffected by a dollar devaluation; all she needs her dollar balances for, after all, is to pay for primary-products imports, as she buys little else on the outside and has no foreign debt. The United States, too, may not suffer, and may even benefit as American industrial exports become more competitive. But while the primary producers sell mainly in dollars, they have to pay in other developed-nations currencies for a large part of their industrial imports. The United States, after all, although the world's leading exporter of industrial goods, still accounts for one-fifth only of the industrial goods on the world market. Four-fifths are furnished by others—the Germans, the Japanese, the French, the British, and so on. Their prices in U.S. dollars are likely to go up. This then might bring on a further deterioration in the terms of trade of the already depressed primary producers. Some estimates of the possible drop go as high as 10 percent, which would entail considerable hardship for metal mines in South America and Rhodesia, and also for farmers in Canada, Kansas, or Brazil.

      There is, however, one more possible scenario. And it involves no “landings,” whether soft or hard. What if the economists were wrong and both American budget deficit and American trade deficit could go on and on, albeit perhaps at lower levels than in recent years? This would happen if the outside world's willingness to put its money into the United States were based on other than purely economic considerations—on their own internal domestic politics, for instance, or simply on escaping political risks at home that appear to be far worse than a U.S. devaluation.

      Actually, this is the only scenario that is so far supported by hard facts rather than by theory. Indeed, it is already playing.

      The U.S. government forced down the dollar by a full third (from a rate of 250 to a rate of 180 yen to the dollar) between June 1985 and February 1986—one of the most massive devaluations ever of a major currency, though called a readjustment. America's creditors unanimously supported this devaluation and indeed demanded it. More amazing still, they have since increased their loans to the United States, and substantially so. There is agreement, apparently, among international bankers that as the United States is the more creditworthy the more the lender stands to lose by lending to it!

      And a major reason for this Alice in Wonderland attitude is that our biggest creditors, the Japanese, clearly prefer even very heavy losses on their dollar holdings to domestic unemployment. For without the exports to the United States, Japan might have unemployment close to that of Western Europe, that is, at a rate of 9 to 11 percent, and concentrated in the politically most sensitive smokestack industries in which Japan is becoming increasingly vulnerable to competition by newcomers, such as South Korea.

      Similarly, economic conditions alone will not induce the Hong Kong Chinese to withdraw the money they have transferred to American banks in anticipation of Hong Kong's “return” to Red China in 1997—and these deposits amount to billions. The even larger amounts, at least several hundred billions, of “flight capital” from Latin America that have found refuge in the U.S. dollar, will also not be lured away by purely economic incentives, such as higher interest rates.

      The sum needed from the outside to keep going both a huge U.S. budget deficit and a huge U.S. trade deficit would be far too big to make this scenario more than a possibility. Still, if political factors are in control, then the symbol economy is indeed truly uncoupled from the real economy, at least in the international sphere.

      And whichever scenario proves right, none promises a return to “normality” of any kind.

      One implication of the drifting apart of symbol and real economy is that from now on the exchange rates between major currencies will have to be treated in economic theory and business policy alike as a “comparative-advantage” factor, and as a major one to boot.

      Economic theory teaches that the comparative-advantage factors of the real economy—comparative labor costs and labor productivity, raw-materials costs, energy costs, transportation costs, and the like—determine exchange rates. And practically all businesses base their policies on this theorem. Increasingly, however, exchange rates decide how labor costs in country A compare to labor costs in country B. Increasingly, exchange rates are a major comparative cost and one totally beyond business control. And then, any firm at all exposed to the international economy has to realize that it is in two businesses at the same time. It is both a maker of goods (or a supplier of services) and a financial business. It cannot disregard either.

      Specifically, the business that sells abroad—whether as an exporter or through subsidiaries in foreign countries—will have to protect itself against foreign-exchange exposure in respect to all three: proceeds from sales, working capital devoted to manufacturing for overseas markets, and investments abroad. This will have to be done whether the business expects the value of its own currency to go up or to go down. Businesses that buy abroad will have to do the same. Indeed, even purely domestic businesses that face foreign competition in their home market will have to learn to hedge against the currency in which their main competitors produce. If American businesses had been run that way during the years of the overvalued dollar, that is, from 1982 through 1985, most of the losses in market standing abroad and in foreign earnings might have been prevented. These were management failures rather than acts of God. Surely stockholders, but also the public in general, have every right to expect managements to do better the next time around.

      In respect to government policy there is one conclusion: Don't be clever. It is tempting to exploit the ambiguity, instability, and uncertainty of the world economy to gain short-term advantages and to duck unpopular political decisions. But it does not work. Indeed—and this is the lesson of all three of the attempts made so far—disaster is a more likely outcome than success.

      The Carter administration pushed down the U.S. dollar to artificial lows to stimulate the American economy through the promotion