(FORTUNE Magazine) – Driving down the dollar is supposed to restore U.S. competitiveness and cut the trade deficit. That was the premise behind the celebrated Group of Five agreement in September of last year, and it is the reason that many American politicians and businessmen are still calling for further reductions in the exchange value of the dollar. Unfortunately, the cheaper dollar has not worked any magic up to now, and evidence is mounting that it may never produce much relief for U.S. manufacturers. Indeed, like Br'er Rabbit being thrown into the briar patch, other countries may even find their long-run competitiveness enhanced by the dollar's decline. The dollar has fallen 36% against the yen and nearly 30% against the Deutschemark since the so-called G-5 agreement. Yet the trade situation has worsened. This may be due partly to normal lags in adapting to the new exchange rates. As the lower dollar pushes up import prices, consumers are supposed to buy fewer foreign and more American goods. But in the short run, before consumers have time to adjust, the higher import prices exacerbate the trade deficit. More important than the current trade deficit is the trend in America's competitiveness. Even here the picture is not bright. Federal Reserve Board figures show declining factory utilization. The auto industry's operating rate, for example, has dropped below 80%. This slowdown suggests that manufacturers do not expect to win back market share from imports in the coming months. And according to the Conference Board, U.S. producers in general are continuing to cut capital spending plans. They would be adding capacity if they believed the lower dollar would stimulate demand for U.S. goods over the long run. Japan presents a striking contrast. Its current account surplus will rise from $49 billion last year to $72 billion this year and will probably be sustained through 1987. Japanese companies have felt pressure from the strong yen, but they have responded with fast action to boost productivity and recapture the advantages they lost.

The yen's rise also has brought a surge of Japanese investment abroad. Capital outflows from Japan exceeded $68 billion in the first seven months of this year. Fully half of this investment has occurred in the U.S., where Japan has emerged as the largest foreign direct investor. This year, Sanyo will build refrigerators in California, Matsushita will make TVs in Washington state, Fujitsu will produce disk drives in Oregon, and Tokyu Car will assemble rail cars in New York. Such investment will help the trade deficit and U.S. employment, but it does nothing for the cause of U.S. manufacturers.

The same pattern is evident elsewhere. Matsushita, Asahi Glass, Fujitsu, and other Japanese companies are investing aggressively throughout Asia. While many American enterprises are doing likewise, the strong yen is giving Japan an edge in the industrializing world, just as the strong dollar formerly did for U.S. investment. Perhaps the best evidence of Japan's strengthening hand since the rise of the yen comes from the world's major stock markets. These markets are driven by expectations, and movements in stock prices provide a kind of unbiased collective judgment about what the future holds. So far, that judgment seems to identify Japan not as a loser but as a prime beneficary of the lower dollar. While the Dow Jones Industrial Average has risen an impressive 38% since the G-5 agreement, the Nikkei Stock Average has risen 40% in yen and 118% in dollars. THE MARKET'S favorable assessment of Japanese industry in the face of a rising yen is illustrated by the case of the world's automakers. If a lower exchange rate is expected to help a company's competitive position, its value should rise relative to the value of its competitors. By adding up the market values of all the securities issued by publicly owned auto companies around the world, one can estimate the value investors attach to the auto industry as a whole. If exchange rates affect competitiveness, fluctuations in them should show up as changes in the share of the worldwide industry value claimed by a country's manufacturers. On September 20, 1985, just prior to the G-5 agreement, the value of U.S. auto companies amounted to 41.3% of the value of the world automobile industry. As the dollar dropped immediately after the agreement was announced, so did that percentage. By November 20 the U.S. value share had fallen to 38.7%. That implies a transfer of value from U.S. automakers to foreign competitors of more than $5.5 billion. Some 28% of this amount went to Japanese companies. The largest gainers were German manufacturers, whose value share rose from 15.2% to 16.9%. Such a transfer of value away from U.S. manufacturers is the exact opposite of what the conventional wisdom on exchange rates and competitiveness would predict. Why has the conventional wisdom proved wrong? A major reason is globalization. In the past, most companies operating internationally either produced goods at home and exported or built plants abroad and sold in the local market. As a result, the profits on foreign sales were heavily dependent on the exchange rate. Whether a company exported or manufactured abroad, profits rose as its currency weakened and fell as its currency strengthened. Changes in the exchange rate affected virtually all companies with foreign sales and the country's balance of payments. Thus, it made sense to think of a country's competitiveness and to associate competitiveness with the balance of trade. Today's economic circumstances are not so simple. Many product markets such as motor vehicles, semiconductors, and telecommunications equipment are global in the sense that companies must sell beyond their borders to achieve sufficient volume to justify huge up-front R&D expenditures and to achieve full economies of scale. Thus, a company's competitive positions in various markets around the world are interdependent. And exports boost long-run cost competitiveness as much as they result from it. As companies become global they are much less easily identified with particular countries. They buy raw materials or components in one country, assemble them in a second, and sell finished products in a third. Even when it is possible to identify a company with a country, it is very difficult to assess the effects of exchange rates on its competitiveness. Japanese companies doing business in Japan, for instance, find that the higher yen makes imported materials cheaper, particularly those denominated in dollars. Capital markets also are undergoing globalization. Today a company treasurer can search the world for the cheapest funds, borrowing in whatever currency is most attractive at the moment and swapping into the currency the company needs. This ''currency-blind'' approach to finance has two implications. First, many companies' international financial arrangements have become more complex, further complicating the task of understanding exchange rate effects. Second, the proliferation of markets and financing instruments creates opportunities to lessen the sting of adverse exchange rate movements or even turn them to advantage. All these developments have blurred the connection between exchange rates, competitiveness, and the balance of payments. Three important lessons emerge from all this. First, U.S. managers must widen their understanding of foreign exchange exposure. A company's true exposure goes well beyond the translation impact on its balance sheet or on the dollar value of foreign payments and receipts. What really matters is the effect of exchange rates on the company's future performance. This in turn depends largely on how intelligently managers respond to currency changes in their operating and financial decisions. Second, the U.S. should remove the trade balance from its pedestal as far as public policymaking is concerned. To a considerable extent, today's trade balance reflects decisions taken throughout the past decade by many economic actors around the world. Decisions made today on competitive issues will show up in the trade figures of the 1990s. To get investors' best judgment on whether today's decisions make sense, it pays to examine changes in the nation's worldwide value share in key industries. Finally, policymakers must remember that the relationship between exchange rates and competitiveness is neither simple nor stable. In many industries, especially fast-growing ones, a company's future depends on heavy investment in markets around the world. A strong home currency may aid foreign investment. This is just the opposite of the old notion that weaker currencies promote competitiveness. TO THE EXTENT that the G-5 agreement stemmed a rising tide of protectionist trade legislation in Congress, it has been useful. But as corrective economic policy it has failed. Lee Iacocca, the National Association of Manufacturers, and others take this to mean that the dollar has to be pushed down still further against the yen and European currencies, and that Korea, Taiwan, Singapore, and other industrializing nations must allow their currencies to rise. This approach is doomed to fail. At home it may squander taxpayers' money and fuel inflation as the Fed speculates against the dollar. Abroad, it will create a hothouse for change that will ultimately yield bigger, stronger, and better organized foreign competitors. Like the rest of the world, U.S. manufacturing must learn to exploit the opportunities presented by changing currency values and not merely hedge against their costs. Leveling the playing field, even if it really needed it and we knew how to do it, is no substitute for learning how to play the game better.