Fritz Machlup, Der Außenwert des Dollars (1974)

This printed Kiel lecture is an abridged expert memorandum drafted in August 1973 for the German Council of Economic Experts, asking how to judge the dollar’s external value and whether it was undervalued against the floating currencies, especially the D-Mark. Its historical setting is the breakdown of fixed parities, but its scope is methodological: Machlup uses the dollar problem to ask what “undervaluation,” “overvaluation,” and “equilibrium exchange rate” can mean once exchange rates are formed by markets, expectations, capital flows, and official interventions.

Machlup’s first conceptual move is to make “misvaluation” a claim about judgment, not a directly observable fact. Under fixed parities, calling the dollar overvalued criticizes official policy; under floating rates, calling it undervalued criticizes market expectations and predicts later correction.

Die Behauptung, der Dollar sei über- oder unterbewertet, drückt immer ein Mißtrauensvotum aus.

English translation: The assertion that the dollar is over- or undervalued always expresses a vote of no confidence.

This leads him to reject simple purchasing-power comparisons. Price indices may illuminate large inflations, but small index differentials cannot determine exchange rates, because trade goods, services, transfers, investment income, and capital movements all affect foreign-exchange supply and demand.

Auf relativ kleine Veränderungen der Preisindexzahlen ist die sogenannte Kaufkraftparitätentheorie nicht anwendbar.

English translation: To relatively small changes in the price index numbers, the so-called purchasing-power parity theory is not applicable.

The lecture’s middle sections broaden the analysis from the current account to the “basic balance” and then beyond it. Machlup insists that long-term and short-term capital movements cannot be cleanly separated by statistical maturity, since both may express portfolio shifts caused by expectations, risk, and asset preferences.

Die in der Zahlungsbilanzstatistik übliche Trennung von langfristigem und kurzfristigem Kapitalverkehr basiert mehr auf oberflächlichen Erscheinungsformen als auf kausaltheoretischen Unterschieden.

English translation: The separation of long-term and short-term capital movements customary in balance-of-payments statistics rests more on superficial outward appearances than on differences of causal theory.

Capital flows are therefore not auxiliary disturbances but central price-forming forces. A capital inflow permits a current-account deficit; a capital outflow requires trade adjustment or exchange-rate movement. Machlup’s anti-mercantilist point is that exporting goods for paper claims is not inherently superior to importing real goods financed by capital inflow.

Ich halte Änderungen in den Kapitalströmen für die stärksten aller auf dem Devisenmarkt wirkenden Kräfte.

English translation: I regard changes in capital flows as the strongest of all forces at work in the foreign-exchange market.

A second major move is temporal. Trade elasticities are small in the short run and larger only over time: contracts, production changes, consumer substitution, and industrial reorganization delay adjustment. Hence a currency may fall sharply after a capital-flow shock and then recover as trade volumes respond. Yet the “final equilibrium” is only a model device, because new shocks constantly arrive before the old adjustment is complete.

In der Wirklichkeit gibt es also kein endgültiges Gleichgewicht.

English translation: In reality, therefore, there is no final equilibrium.

Machlup’s empirical application to the dollar reads the 1969–72 balance-of-payments data through this framework. Official support purchases had hidden the market pressure on the dollar; later, “fear selling” by private and official dollar holders amplified its fall. The slow improvement of the U.S. trade balance did not disprove exchange-rate adjustment, because deliveries, payments, and real reallocations lag behind price changes, while business-cycle divergence also matters. The appendices reinforce the argument: one graphically models short-, medium-, and long-run adjustment; the other classifies causes of exchange-rate “disalignment” beyond mere inflation differentials.

The conclusion is deliberately skeptical. Machlup does not deny conditional forecasts; he denies that experts can compute a uniquely correct, durable external value of the dollar from purchasing-power parity, the basic balance, or any single statistical indicator.

Auf Grund dieser Thesen muß die Idee, den Außenwert des Dollars zu bestimmen, als praktisch unvollziehbar aufgegeben werden.

English translation: On the basis of these theses, the idea of determining the external value of the dollar must be abandoned as practically unrealizable.

The practical result is modest but relevant: in a post-parity world, exchange-rate analysis must combine expectations, capital mobility, official reserve policy, trade elasticities, and time. Machlup ends not with a “true” rate but with a conditional range under calm assumptions.

Man kann bestenfalls sagen, daß ohne Interventionen, ohne sensationelle Ereignisse und ohne bemerkenswerte Änderungen in der wirtschaftlichen und politischen Situation der wichtigsten Länder der Dollar zwischen 2,40 und 3,00 DM schwanken kann.

English translation: At best one can say that, absent interventions, sensational events, or notable changes in the economic and political situation of the most important countries, the dollar may fluctuate between 2.40 and 3.00 DM.