Q&A; : Is Dollar’s Decline a Sign of Crisis?

The dollar’s steep fall in the last few days, to all-time lows against the German mark, has many investors and others worried about possible disastrous effects. Here are some answers to key questions about the meaning and implications of the declining greenback:

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Q: Does the dollar’s decline signal a true crisis, with baleful effects for the U.S. economy--including perhaps a crash in stock and bond markets reminiscent of 1987?

A: No. Most economists and currency experts see little adverse effect, and even some benefit, for the U.S. economy. And even though some investment managers see further declines for the U.S. stock and bond markets, culminating in a slight rise in U.S. interest rates, nobody argues that a crash is coming as in 1987. Today’s conditions are different in many ways--chief among them that the Federal Reserve and the German central bank are cooperating to moderate currency movements.

Most of what is happening stems from the German government’s need to borrow internationally to finance redevelopment of the former East German states. This keeps German short-term interest rates at 9% and more, compared to U.S. interest rates of 3% to 4%. And so the dollar is down, to 1.40 deutschemarks from 1.65 only a few months ago, because corporate treasurers, banks and other big investors around the world are shifting loose dollars into deutschemark accounts and securities.

But Germany’s economy--and all the others in Europe--are suffering from those high German interest rates. “There are increasing chances of recession across Europe,” declares William A. Brown, chief economist of J. P. Morgan Co.

On the other hand, the lower dollar strengthens the U.S. economy by allowing U.S. products to be attractively priced in world markets that are not going into recession. “Europe is no longer the whole story,” says economist John Mueller of the consulting firm Lehrman Bell Mueller Cannon. “U.S. exports are building up in Latin America and the countries of Asia outside Japan--especially in China.”

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Q: That’s all reassuring, but the dollar has been falling steeply the last few days and U.S. stocks and bonds along with it. Is everybody crazy or could there be a major downside to these events?

A: There could be. The nations of Western Europe remain the biggest customers for U.S. exports--buying more in 1991 than all of non-Japan Asia and Latin America put together. So their recession can double back on us, cutting U.S. exports and jobs and stalling the U.S. economic recovery.

“Why is the crisis occurring at this time? Because the markets realized that the U.S. wanted the dollar to fall further to help its exports,” says the investment manager of a mutual fund group who prefers to speak anonymously.

That’s a reference both to President Bush’s emphasis on exports in his acceptance speech last Thursday and to the subtle actions of the Fed and Germany’s Bundesbank, which are buying dollars but not aggressively. Such tepid action signals traders in global markets--where $500 billion is traded every day--that a bet against the dollar is a safe one.

“I expect the markets to be disorderly for another few weeks,” says the investment manager. “They will calm down when a compromise is reached, with the Germans lowering interest rates half a point and the Fed raising U.S. rates a half point.”

Thus U.S. stocks and bond prices are falling because investors anticipate U.S. interest rates turning higher. Another reason for the decline in stocks is that incipient recession in Europe, and in Japan as well, lower the foreign earnings of major U.S. companies such as IBM, Ford and others.

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Q: Higher U.S. interest rates? Are we looking at a rerun of the 1987 crash?

A: The answer is no. Despite superficial similarities, the currency crises of 1992 and 1987 are fundamentally different. Back then there was a real argument between the United States and Germany over interest rates. Today there is understanding and cooperation.

“The Fed and the Bundesbank are intervening (buying dollars to stem the currency’s decline) together but not aggressively,” explains Kenneth McCarthy, head of Economic Intelligence Co., a foreign exchange consulting firm. “However, if they really want to influence the market they can, and the thinking is they will step in at some point to get the dollar back closer to 1.45 marks.”

Meanwhile, the U.S. stock market’s decline--5.5% from its peak--is mild compared to the 20% and greater declines of stock markets in Europe.

But that doesn’t mean U.S. stocks are in for a further drop, argues Charles Clough, chief investment strategist for Merrill Lynch. U.S. markets reflect American industry’s global competitiveness, he says. “This crisis is not caused by U.S. inability to sell goods, or by U.S. inflation, but by Germany’s need to borrow,” says Clough. “How much of a bribe is Germany willing to pay to attract international money? If German rates go to 14%, the dollar will go down further. But it won’t hurt us.”

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Q: Big money, global trading--what does it all mean for regular people?

A: It means that foreign travel costs more--which is why both Europeans and Americans are choosing to visit Disneyworld in Orlando, rather than EuroDisney in Paris.

Normally, the falling dollar would mean higher prices for imported goods--and a rise in U.S. inflation. But in this environment, with business slow and competition intense, foreign suppliers will feel the pain more than U.S. consumers.

Theoretically, for example, the Volkswagen GTI that cost $12,400 last March, when the dollar was worth 1.65 marks, should be going up in price by 18% today to recover the shift between dollar and mark for Volkswagen in Wolfsburg, Germany. That would mean a new price of $14,600 for the VW sold in America.

But it would be a brave or foolish dealer who raised prices that much in today’s car market. So the American customer won’t notice a change, but the Volkswagen company will make less profit, and there will be leaner times for workers in Wolfsburg.

Looked at in that way, it’s easy to understand why Americans don’t feel that the dollar’s decline presents much of a crisis.