MIDEAST CRISIS HITS HOME : Dollar : U.S. Currency Skids as Its Status as Safe Haven Fades : NEWS ANALYSIS

The dollar fell against most major currencies Monday, despite a clear risk of military conflict in the Middle East. And that is both unusual and a potent indicator of present and future economic events, financial experts say.

Normally the dollar is a “safe haven” currency, bought heavily by foreigners in times of high tension. But in this crisis it has been bought tepidly.

“The dollar has been abysmal,” remarks Allen Sinai, chief economist of Boston Co. It gained only slightly last week following Iraq’s invasion of Kuwait and fell on Monday despite a worsening of the crisis.

That sent a signal to financial markets. “I think the dollar is losing some of its safe haven status,” said a London currency dealer. “People are focusing on the fundamental weaknesses in the U.S. economy.”

He was referring to the belief among global investors that with the U.S. economy teetering close to recession, the Federal Reserve will lower interest rates--which would make U.S. government bonds less attractive to foreign investors.

In fact, it’s more than a matter of interest rates. World markets are focusing on what is perceived to be weaknesses in the American character, says a global money manager. And it is that focus that offers financial markets a forecast of what’s ahead for the U.S. economy, and explains much of what is happening today.

In the eyes of international money markets--where multinational businesses, banks and individuals trade currencies around the clock--the United States is regarded as having abandoned the dollar’s value in recent years because it has borrowed from abroad to fund the U.S. government deficit, and run a huge trade deficit because it refused to curb domestic consumption.

As a result, the United States has flooded the world with dollars, and their value has declined almost 40% against both the German mark and the Japanese yen--meaning that the purchasing power of a dollar in Germany or Japan is now only 60% of what it was five years ago.

This has been devastating for the oil producers--because oil is bought and sold in dollars. So members of the Organization of Petroleum Exporting Countries--be they Arab or Venezuelan, Indonesian or Nigerian--have seen their oil revenue purchase less in machinery or consumer goods from Germany or Japan, or France or Britain. With the dollar worth 20% less in German marks than a year ago, even Volkswagens are expensive--not to mention Mercedes.

That declining purchasing power made oil producers restive, and that opened a door for Iraq’s empire-building President Saddam Hussein. To be sure, dollar depreciation doesn’t explain, much less excuse, Iraq’s takeover of Kuwait. But dissatisfied oil producers backed Hussein in OPEC councils; they wanted to hit back at the United States. Hussein played on those emotions.

But Hussein may be a passing problem; with the world united against his aggression, he may not even survive as leader of Iraq. But oil and the dollar will continue to be a problem, say analysts. No doubt the price of oil will be higher than it was before the crisis--OPEC had already voted to increase the price to $21 a barrel from $18.

More important, say analysts, the OPEC producers may try to prevent future erosion of their purchasing power, perhaps by denominating oil in several currencies. They would then be able to demand payment in marks or yen or dollars.

And that would be disadvantageous for the U.S. economy. “Fewer countries would have to acquire or keep dollars to pay for their oil, and so the dollar’s value would fall,” explains economist Sinai.

In fact, he adds, that is already happening as the markets buy the mark and sell the dollar. (The yen has been weak also in this crisis because of Japan’s total dependence on imported oil; but Japan’s economy is regarded as strong, and it may attract the global investment the lagging U.S. economy may lose.)

The logical conclusion, say analysts, is that the Federal Reserve will have to keep interest rates high to “defend” the dollar. Otherwise, a falling dollar--which could help exports--would also bring higher inflation in a country that imports half its oil and which owes so much abroad after years of borrowing. “The accumulated budget deficits at the federal and state levels limit our alternatives,” says Sinai.

The upshot is that the U.S. economy is in a difficult position, needing high interest rates to curb inflation but low interest rates to avoid recession.

Is there any way out? Well, the United States might hope to carry on borrowing from abroad, counting on the world’s gratitude for putting its military on the line in the Middle East to protect international oil supplies. But the battering of the dollar shows what the cold, calculating world thinks of that hope.