Dollar Plummets 2.5% as Major Central Banks Flood Currency Markets : The Fed Wages Its Battle to to Stabilize Currency From a ‘War Room’ in New York
It is 3:30 a.m. and currency trader Meg Brown is just “getting into the office”--trudging down the austere hallway on the seventh floor of the darkened New York Federal Reserve Bank and into the cluttered environs of the Fed’s currency trading center.
The Fed is preparing for a day of possible turmoil in the foreign currency markets, and the trading center is the central bank’s war room--a computer-bedecked nerve center from which the Fed conducts skirmishes, psychological warfare and, occasionally, major sorties in the markets to influence the dollar’s rate.
The mission is a critical one that affects virtually every American’s livelihood. If the dollar rises too far, it makes imports more attractive here and makes U.S. goods less competitive abroad, costing jobs here at home. If the U.S. currency falls too sharply, it can kindle new inflation. Too many ups and downs make business uncertain and tend to stifle trade.
Trying to Calm Jitters
Brown, who is the trading room’s equivalent of an advance scouting party, is assigned essentially to conduct early intelligence operations--to find out what’s going on in currency markets around the world, to divine the mood of traders and to look for clues of what Fed strategists are likely to face during the remainder of the global trading day.
Depending on what she finds, the Fed may intervene in the markets by buying or selling billions of dollars, West German marks, Japanese yen and other currencies, either to calm the market’s jitters or to counter an unwanted trend. Whatever is decided is carried out by the New York Fed.
Brown’s early morning reconnaissance is the start of a long day of continual sounding efforts and strategy sessions that include Fed staffers, bank traders, officials of foreign central banks, senior Treasury Department and Federal Reserve Board officials in Washington and--occasionally--even the President.
On Monday, as it happened, the central bank had fired its first salvo even before Brown got to the trading room. In a coordinated attack with other central banks of other big industrial nations, the Fed aggressively bought foreign currencies with dollars in foreign exchange markets both here and abroad, to underscore a fresh warning by finance ministers of the seven leading industrialized democracies that they do not want the dollar to rise further.
Many economists are skeptical about whether such intervention can have any long-term impact on the value of the world’s currencies. But John Williamson, an exchange rate specialist at the Washington-based Institute for International Economics, says it remains the most visible and readily available weapon for the seven nations.
“If the Fed can’t keep things in check, there’s a danger that the foreign exchange markets will run amok,” said Williamson, who previously was on the staff of the 152-country International Monetary Fund. “And once that happens, you can’t count on very much. The dollar could continue up or down, and things could get out of control.”
By any standards, the job is not an easy one. Not only must the Fed keep abreast of constantly changing market trends, but it also must develop and carry out a strategy that will prove convincing to traders here and in other countries. And it is not always easy to pinpoint what is forcing the dollar up or down.
Two Fridays ago, for example, the dollar gyrated wildly on rumors that several big New York banks were in financial trouble; that West Germany and Japan were about to raise their interest rates, and that President Bush had been shot. All proved erroneous. But the Fed had to contend with them just the same.
Markets Volatile
Harvard University economist Richard N. Cooper explains that there is no great mystery to the Fed’s operations. “The basic idea is simple,” he says. “If you want to influence any price in any market, you buy or sell that commodity. If you want to drive the dollar up or slow its rise, you buy dollars in large numbers. If you want to push it down, you sell.”
But the markets are so volatile that the Fed’s intervention efforts frequently take on the intricacy--and excitement--of modern-day submarine warfare. The central bank’s game is to outguess--and ultimately spook--the world’s currency traders into behaving the way policy-makers want. With markets open somewhere in the world 24 hours a day, it is a serious challenge.
The war room that Brown opens each morning is sophisticated enough to serve as a movie set for “The Hunt for Red October.” Two giant video monitors suspended over a carousel of computer terminals flash the latest doings in financial markets around the world. One, in yellow, green and bright pink, carries currency prices. The other--black on white--is a financial news ticker.
Brown and seven other currency traders have batteries of push-button hot lines to key officials at the Fed and the Treasury, trading rooms of major commercial banks and the Fed staffers’ own counterparts in central banks in Europe and East Asia. Atop the carousel in the center is a giant lazy Susan to help cope with any paper work.
Although decisions on whether to intervene technically are shared by the Federal Reserve and the Treasury, in practice the final decision ultimately rests with the Treasury secretary. The Fed generally has been willing to carry out whatever dollar policy the incumbent Administration has set.
The Fed buys and sells currencies--primarily dollars, marks or yen--on the foreign exchange markets much as any other trader would.
Brown or another Fed trader calls a counterpart at a major private U.S. bank--Morgan Guaranty Trust Co., for example. The Morgan trader then calls other traders at, perhaps, Commerzbank in Frankfurt, West Germany, or Sumitomo Bank in Tokyo, offering either to sell or to buy dollars in exchange for foreign currencies.
Break-Even Operation
The transactions--consummated by telex rather than with wheelbarrows full of currencies--are then either deposited in the Fed’s own coffers or the Treasury Department’s exchange stabilization fund. The intervention is financed half by the Treasury, which draws on its $10-billion exchange stabilization fund, and half by the Fed, which has the power to create its own money for such use. The two agencies hold billions of dollars in foreign currencies, largely on deposit in foreign central banks.
Any profits are deposited in the Fed’s own accounts, returned to the exchange stabilization fund or invested in interest-bearing accounts in other central banks, which essentially pay market rates. The Fed is neither a big earner nor a big loser. Officials say that over time, the profits from dollar transactions essentially balance the losses.
Jerry Jordan, an economist for First Interstate Bancorp in Los Angeles, contends that the Fed is bound to lose big from its current sales of dollars because the central bank is running counter to the trend in the market, which has been pushing the dollar higher in the face of the tight-money policies that the Fed has maintained. Although the Fed’s latest report shows that it made a profit on its foreign exchange operations in the May-July period, Jordan contends that alternative calculations show the central bank to be actually losing money.
Sometimes the Fed wants to intervene visibly in the markets, to send a clear signal in hopes that other traders will follow. Brown and other Fed traders openly call banks and brokers to place buy or sell orders. With the markets’ penchant for gossip, the word spreads worldwide in only a matter of minutes.
But occasionally Fed tacticians operate clandestinely, to catch traders off balance and--possibly--increase chances that they will be able to get more bang from their intervention bucks. In that case, brokers may not disclose that the Fed placed the order. The moves often catch markets by surprise.
Doesn’t Always Work
What gives Brown and other Fed currency traders the edge is that they are privy to “insider information”--ranging from what the statistics that are scheduled for publication that day will show to what policy actions their governments are about to take. The markets can speculate, but they never know for sure.
For all the Fed’s efforts to manipulate the dollar’s value, the markets sometimes seem to defy explanation. Traders the world over make their decisions to buy or sell in seconds, without waiting to see whether their information is correct or complete. Often, markets react according to what they expect a statistic or announcement to be, not to what it really is.
But when the Fed and the other central banks manage to score a hit, the markets remember. Private currency traders are still smarting from the now-famous “bear trap” of December, 1987, when the central banks allowed the markets’ “bears”--that is, the pessimists--to drive the dollar down excessively, and then struck back with massive intervention that blunted the descent and left many speculators burned.
Gretchen Greene, chief of the Fed’s currency trading operations, insists that there was no actual bear trap--just “steady intervention” that remained “unappreciated” by the markets until it was too late. But outsiders count the ploy as one of the Fed’s most successful.
Intervention can also depress the dollar’s value. David Hale of Kemper Financial Services in Chicago argues that the dollar would have been far higher now if authorities had not sold dollars in the past few months, when the dollar was rising.
One problem facing would-be interveners these days is the sheer size of the global currency market. Trading has swelled from a few billion dollars’ worth of transactions each day in the early 1970s to a staggering $500 billion a day now. And the market is still growing about 30% every year.
Have the Resources
Stephen H. Axilrod, a former senior Fed strategist now vice chairman of Nikko Securities International in New York, argues that the volume of transactions has become so large that it threatens to swamp the resources of central banks. “You really do have to do more in the market” to achieve the same effect, he said.
But Greene insists that the central banks’ coffers are still adequate, if only because they merely have to influence the markets at the margin and reverse prevailing trends. “What we’re dealing with is the height of the waves, not the depth of the entire ocean,” she said.
Just the same, the amount of intervention required still can be eye-popping. A recent report by Sam Y. Cross, the New York Fed’s vice president for foreign operations, showed that the United States sold a staggering $11.9 billion in dollars from May to July, the largest U.S. intervention on record.
And Monday’s activity suggests that the Fed and other central banks will continue to intervene heavily whenever they feel a need to counter what the currency markets are doing. And the New York Fed’s Brown will still be there for the 3:30 a.m. shift.
