THE DOLLAR’S FREE FALL : Terminal Illness or an Image Problem? : Some Say Buck Is Beyond Hope; Others Blame Temporary Doubts

The dollar’s latest free fall, while unnerving Wall Street, remains an abstract concept to most Americans if they aren’t trying to buy a cup of coffee in Tokyo or Berlin.

Most consumers and investors understand that a weaker currency has implications, good and bad. But hasn’t the dollar been falling for 10 years? Why now the extreme pessimism about the buck, and the increasing talk that it has finally lost its post-World War II status as the global “reserve” currency--the premier paper store of value?

That loss-of-status argument, by definition, rests on the assumption that something is different this time around for the dollar--that perhaps we’re finally paying the price for 15 years of national trade and budget deficits that have saturated the world with greenbacks.

Put too much of any commodity on the market, after all, and its price will drop. Currencies are commodities. Flood the market with enough paper, and it’s conceivable you can make it worthless.

That has been unthinkable, as far as the dollar has been concerned, since World War II. As the world’s reserve currency, a role inherited from the British pound, the dollar has been the paper of choice for central banks, corporations, investors, drug smugglers and anyone else looking for a relatively stable store of value and universal medium of exchange. Oil and other key commodities are priced and traded in dollars. The buck is accepted everywhere.

In that sense, as long as the world economy grew, there seemingly could never be too many dollars out there--or too many dollar-denominated securities such as U.S. Treasury bills and bonds. The dollar could be devalued, but in the end it would still be the one paper currency that everyone had to own.

But Ray Dalio, chief investment officer at Bridgewater Group, a Wilton, Conn., investment firm, is among the dollar bears who have long believed that the U.S. currency’s mystique would eventually decay to a point of no return--a point at which many global investors would decide that permanently holding Japanese yen or German marks as reserves made more sense than holding American dollars.

With the dollar down a stunning 7% against the yen and 6% against the mark over the past week, that turning point may have been reached, Dalio warns.

“The dollar’s decline is a symptom of a capital-withdrawal issue,” he says. In the same way that frightened global investors are pulling capital out of the collapsing financial markets of Latin America, they are increasingly taking it out of the United States as well, he says.

Money moves, Dalio notes, as fast as technology will let it. And the growing electronic linkage of financial institutions and markets worldwide with capitalism’s boom since 1990 means investments can be easily moved, and converted, across borders today, far more efficiently than even 10 years ago.

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Isolating the exact trigger for this dollar panic isn’t necessary now, Dalio contends. Maybe it was Federal Reserve Chairman Alan Greenspan’s recent suggestion to Congress that the Fed is focused more on aiding the economy than fighting inflation. Any threat of higher inflation, after all, erodes the store-of-value function of a currency.

Or maybe it was President Clinton’s Mexican bailout package, which was viewed as creating a potentially open-ended credit line to Latin America (i.e., how could the Administration say no to Argentina after covering Mexico?), threatening a new flood of dollars on the world market.

Whatever the cause, dollar bears like Dalio see only one way to arrest the currency’s decline, given that the U.S. economy is a net debtor that relies on foreigners for 25% of each new dollar of credit it uses: Like hapless Mexico, the United States will have to pay higher interest rates to keep global investors in its currency, Dalio says.

He expects a two- to three-percentage-point boost in short-term interest rates by the Fed this year--a move that would bring the impact of the dollar’s decline home to Americans as surely as it is now ruining the vacations of U.S. tourists abroad.

But while other Wall Streeters concede that there are ample reasons for the dollar’s latest weakness, most don’t see this as the beginning of an unprecedented and ruinous flight from dollars by global investors.

“Every time this happens, they call it a disaster,” scoffs James Tobin, economist at Yale University. Then the dollar stabilizes, and life goes on.

Robert DiClemente, economist at Salomon Bros. in New York, notes that there are more than a few major differences between the Mexican peso’s collapse and the dollar’s slide. Mexico is a Third World economy that adds little net value to the world economy. The United States, in contrast, is arguably the most competitive of the industrialized countries and is still the largest economy on the planet, DiClemente says.

Moreover, he notes, the backdrop of the U.S. economy isn’t fundamentally weak. On the contrary, inflation remains low, corporate profitability and cash flow is tremendous, and the banking system is sound. The dollar’s decline, DiClemente says, “is more an image problem” that has to do with doubts about Fed and Clinton Administration policy than a reflection of the private sector’s health in the United States.

And indeed, the U.S. private sector--or at least exporters--will grow even stronger as the weak dollar makes their products cheaper abroad.

As for the world’s sudden appetite for yen and yen-denominated securities, James Grant of Grant’s Interest Rate Observer newsletter in New York notes that Japanese stocks sell for among the highest price-to-earnings ratios on Earth, while the Japanese banking system is “up to its neck in unacknowledged debts” from the speculative “bubble” era that ended five years ago.

With those kinds of fundamentals in the Japanese economy and its markets, Grant says, many investors may more logically ask why the yen isn’t going down in value instead of up.

Nor have the Japanese or the Germans ever suggested that they would relish the idea of becoming the world’s reserve-currency countries. If anything, the Germans in particular have loathed the idea for the very reason that it takes away their full control of their own destiny, and vests it partly with foreigners.

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Still, in the short term if not the long term, the driving force in currency markets is simple supply and demand, Grant says. While Americans still own the majority of their own stocks and bonds, the fact that the dollar has been the world’s reserve currency for 50 years means dollars are in the hands of more foreigners than are yen or marks.

“What changes a price in the market is the marginal investor changing his mind,” Grant says. “The world has more or less complacently held dollars all these years. It’s playing with matches to dare them to continue holding them” in the face of U.S. fiscal or monetary policies that seem a threat to the currency’s health.

* PASSING ON THE BUCK

Dollar hits new lows. A1

* OTHER MARKETS

Dow industrials lose 34.93. Peso falls to new low. D3

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A Decade-Long Slide

By 1980, Japan’s economic strength and low inflation compared to the United States began to make the yen more desirable than the dollar. Large U.S. trade and federal budget deficits continued to work against the dollar’s value in the mid-1980s. The decline slowed somewhat with the peaking of Japan’s “economic miracle” in the early-1990s, but in recent years the yen has recovered at the dollar’s expense. Yen per dollar, monthly closes except latest:

January, 1980: 239.37

November, 1982: 276.74

Tuesday: 90.05, Down 2.75

Source: Datastream International