Dollar’s Plunge May Keep Rates Up, Economists Warn

The Bush Administration’s seeming indifference to the free-fall plunge in the value of the dollar is likely to become a major impediment to lower interest rates, even if the White House and Congress reach agreement on the budget, economists and Federal Reserve officials warn.

Although Treasury Secretary Nicholas F. Brady said this week that the greenback’s fall to near-record lows against the Japanese yen and the German mark does not worry him, the dollar’s decline will add to inflationary pressures in the United States, making it more unlikely that the Fed will take any significant action to lower interest rates after a budget agreement is reached.

The lower dollar eventually could spur exports and thus stimulate the economy but in the short run its decline could be expected to discourage foreigners from investing in the United States, thus making it increasingly difficult for the government to finance its mounting debt.

And, if America goes to war in the Persian Gulf, the dollar’s plunge will complicate U.S. efforts to finance a massive increase in military spending, government and private analysts say.

By Friday, the dollar was just above a new record low it hit Thursday against the German mark, while the U.S. currency rose slightly Friday against the Japanese yen after declining to its lowest level in 21 months against the yen the day before. The dollar closed Friday at 1.50 marks, up from Thursday’s 1.4975 marks, the dollar’s lowest level since the German currency was created in 1948. Meanwhile, the dollar closed Friday at 125.9 yen, up from Thursday’s 124.4 yen.

The dollar’s decline is already putting additional pressures on the Federal Reserve to tighten monetary policy, just as the Bush Administration is openly campaigning for the central bank to lower rates once a deficit-reduction package emerges from Washington.

“The dollar’s weakness is an argument against easing interest rates,” said Robert Black, president of the Federal Reserve Bank of Richmond. “It makes it a bit harder to cut rates.”

In fact, officials at the Federal Reserve, who see inflation-fighting as their primary mission, are frustrated by the Bush Administration’s posture toward the dollar at a time when the White House is also pushing for easy money to push rates down.

They point out that a falling dollar and a looser monetary policy tend to worsen inflation, which is already rising. The Labor Department reported Thursday that consumer prices rose at a 9.5% annual rate in September.

“It’s a fact of life that you can’t have a rapidly falling dollar and an easier (interest-rate) policy at the same time,” noted one Fed official.

“The weaker the currency, the more reluctant the central bankers become to cut interest rates,” observed John Williamson, an economist at the Institute for International Economics in Washington.

Still, the Bush Administration apparently disagrees with the Fed, and remains publicly committed to a hands-off policy on the dollar. Brady asserted this week that he believes the dollar’s decline has been “orderly” and added that the currency markets remain “stable.”

While other Bush Administration officials complained that Brady’s public comments were “inappropriate” because they tended to depress the dollar further, they refused to disagree with his position.

Yet Brady’s views stand in sharp contrast to the policies followed during the Reagan Administration, when then-Treasury Secretary James A. Baker III won international cooperation from the other major industrial nations to intervene in currency markets.

For several years in the late 1980s, the United States and its allies established fairly rigid targets for exchange rates between the world’s major currencies.

But the Bush Administration has given up on those activist efforts, in part because of its belief that a cheaper currency can help the economy.

While a cheap dollar makes it far more expensive for Americans to travel overseas, the decline in the currency’s value does help U.S. businesses by making American exports cheaper and thus more competitive in overseas markets.

Manufacturing firms, especially big exporting industries such as aerospace and construction equipment, should be able to increase their overseas sales, since they can cut overseas prices more easily than their competitors from strong currency nations like Japan and Germany.

“It’s clear the Administration wants the dollar to go lower, because the only source of strength in the economy that they see is in exports,” noted Lawrence Chimerine, an economist and senior adviser to DRI-McGraw Hill, an economic forecasting firm based in Lexington, Mass.

At the same time, many outside economists agree that the dollar needs to fall to reflect the weakened state of the American economy, especially compared to those of Japan and Germany.

The dollar’s decline “accurately depicts the fact that the U.S. economy is deteriorating,” said Barry Bosworth, an economist at the Brookings Institution in Washington.

Yet the speed with which the dollar has fallen is increasing concerns on Wall Street about America’s ability to continue to attract foreign investors, especially if the United States goes to war against Iraq in the next few months and needs to pump up military expenditures.

This year, Japanese and European investors have begun to pull out of the United States in a big way, in part because the dollar’s decline has reduced the value of their dollar-denominated holdings in this country.

In the first half of 1990, for example, foreigners sold $6.8 billion more American stocks than they purchased, a decline which has played a key role in the stock market’s slump.

Meanwhile, foreign investment in government and corporate bonds plunged from $37.3 billion in the first half of 1989 to just $10.1 billion in the first six months of this year, according to Goldman Sachs.

Increasingly, investors in Japan and Germany are keeping their money at home, both because those nations have stronger currencies and because inflation-adjusted interest rates there are now higher than those in the United States.

Even the current crisis in the Persian Gulf hasn’t persuaded foreigners to flock to the dollar, which is normally the safe haven for worried investors.

“This is the first major crisis since World War II during which the dollar has weakened,” noted Robert Hormats, vice chairman of Goldman Sachs International in New York. “It is not that investors see the United States as politically unstable, it is just that the economic negatives in the United States outweigh the political considerations.”