In Topsy-Turvy World, Dollar’s Weakness Is Also a Strength
Don’t be frightened, the sky isn’t falling, only the dollar.
When Germany’s central bank raised a key interest rate on Thursday, the exchange rate of the dollar fell against the German mark because currency traders concluded that international deposits will now flow to mark-denominated bank accounts, which pay 9% to 10%, and away from dollar accounts and U.S. Treasury bills, which pay 4% to 5%.
But that’s just the point, the dollar fell--to 1.47 marks, meaning the mark is worth 68 cents--due to currency plays, international transactions whose meaning for the underlying U.S. and German economies is different from what you may think.
The true meaning for the U.S. economy was on the whole reassuring. It’s significant that U.S. Treasury securities traded calmly, said professionals such as Charles Clough, investment strategist for Merrill Lynch. Interest rates remained low--4.2% on two-year bonds, 7.6% on the 30-year government bond.
That means the markets don’t see inflation threatening the U.S. economy, and do not see the Federal Reserve having to raise interest rates and abort the U.S. recovery in order to support the dollar. Indeed, the U.S. outlook is bright compared to that of other countries.
Admittedly, it’s not easy to understand the international currency markets where--get this--$800 billion worth of speculation goes on every day in currencies, bonds and stocks “in every available time zone from Sao Paulo to Shenzhen (China),” according to Grant’s Interest Rate Observer, a New York newsletter.
The effect of such trading on our economy and our lives is like the moon’s effect upon the tides--the connection is strong but not readily apparent. However, it is explainable.
The reason the Bundesbank raised rates is that it wants to attract capital and help the German government finance the $100 billion a year it is funneling into the East German region. Trouble is, much of that vast expenditure in a crippled, former Communist economy ends up being inflationary for the whole German economy, which is strained now by high interest rates--as was the U.S. economy in the 1970s.
And the effects of Germany’s action on the economies of its European Community partners could be even more devastating. The mark is the chief currency in the European Monetary System, and France, Britain, the Netherlands and others pledge not to allow their currencies to fluctuate more than 2.5% from the mark. So now those nations are forced to keep their own interest rates high, throttling economies that are already close to recession.
Indeed, Germany’s policy is causing so much pain, many analysts said last week, that a change seems likely.
In contrast, the United States is in a much more attractive position, although Thursday’s action is a two-edged sword. The low dollar enhances our ability to sell goods and services abroad. But high interest rates slow the economies of our European customers. That’s unfortunate just when Japan’s economy is slow also. All of that is reflected in Friday’s announcement of falling exports and a growing trade deficit.
Still, the U.S. economy on balance has benefited from the declining value of the dollar. Exports of goods and services have been rising with few interruptions since 1987 and U.S. industry is primed to take advantage of emerging markets in Latin America.
If the dollar’s exchange rate is low compared to a decade ago--when it was worth almost 3 deutschemarks vs. 1.47 today and more than 250 yen vs. roughly 125--today’s rate reflects a much more competitive, low-cost and low-inflation economy. It’s an economy in which recovery may be slow, but real.
And most of all, says Albert M. Wojnilower, senior economist of First Boston Corp., it is the economy of a politically stable country which will peaceably elect a President this fall. Such matters count in global markets--where U.S. stocks, bonds and the dollar got a boost last week when Ross Perot, whom markets saw as unsettling, withdrew from the presidential race.
All those factors--along with U.S. military might--explain why the dollar is the preferred currency in Russia, Romania and many other countries, and why foreign governments continue to buy and hold massive quantities of U.S. Treasury securities as official reserves.
Yes, you say, but don’t the American people pay some price for a lower exchange rate? Sure, imports cost more and foreign travel becomes prohibitive. An ordinary hotel room in London, Paris, Frankfurt or Tokyo costs the equivalent of $200-plus. But U.S. hotels, air fares and tours of the Grand Canyon are relative bargains, luring foreign tourists and adding to a U.S. trade surplus in services.
Turnabout is fair play. When the dollar was sky-high in the early ‘80s, the United States imported extravagantly and ran up a trade deficit. Now, it is working off that deficit by supplying goods and services to other countries.
Confusion arises only when, in the jargon of currency markets, the dollar is called “weak.” But it’s not weak. What those bargains for foreigners mean is that the dollar buys more in the United States. For Americans who earn their living in dollars, that’s not a bad deal at all.
