The U.S. dollar halted its four-day free fall Wednesday after Federal Reserve Board Chairman Alan Greenspan told Congress that the currency's sudden plunge was "unwelcome and troublesome"--testimony that traders and investors interpreted as a sign that the government would not tolerate the slide indefinitely.
In unusually candid testimony before the House Budget Committee, Greenspan also blamed last week's Senate defeat of the balanced-budget amendment for the sudden plunge in the value of the dollar and pointedly warned Congress that the currency will remain under long-term pressure until Washington tackles the deficit.
Greenspan provided fresh ammunition to Republican supporters of the amendment by saying that its defeat sent a signal to the international financial markets that Washington is still not serious about dealing with deficit spending.
Even though investors had suggested the defeat of the amendment was partly responsible for the dollar's sharp decline, Greenspan's remarks were extraordinary because he so rarely gets involved in political disputes over tax and budget policies, which are outside the jurisdiction of the Fed.
Greenspan's comments also highlighted the growing interdependence of global financial markets as his remarks immediately spurred a rebound in the dollar from its record lows against the Japanese yen and German mark. He cautioned that the sliding U.S. currency could increase inflationary pressures on the American economy.
The dollar rose to 1.3935 marks in New York trading, up from Tuesday's record low of 1.3702 marks. Against the yen, the dollar had started the day still in a free fall, declining to 88.75 yen in Tokyo, an all-time low, but it rose to 91.33 yen in late trading in New York. At its lowest, the dollar had fallen 8% against the mark since March 1 and 8.2% against the yen.
Greenspan also insisted that the dollar's decline has had little to do with the Administration's bailout of the Mexican economy, which he supported vigorously. U.S. intervention to prop up the Mexican peso, he said, has been far too small to have any significant impact on the dollar's value internationally.
His remarks had a major impact on the debate over key elements of the Republican "contract with America" on Capitol Hill, where GOP leaders are moving from the battle over the balanced-budget amendment into a fight over proposed tax cuts. The House leadership plans to unveil its package of tax cuts today.
Greenspan noted that he was not a supporter of the balanced-budget measure and said he believes that amending the Constitution is not the proper way to reduce the federal deficit. And he stressed that he believes Congress is more serious today about reducing spending than at any time "in the past 20 years."
Still, he said, financial markets interpreted the vote on the amendment as just one more sign of Washington's inability to confront the hard decisions necessary to put its fiscal house in order.
"I have not supported a balanced-budget amendment, so I'm not saying what should have been done (last week). . . . I'm saying that I was surprised how the markets responded to the defeat. I think that is a reflection of the concern about our willingness to pare the deficit."
On a day when Senate Republicans were meeting to determine whether to punish Senate Appropriations Committee Chairman Mark O. Hatfield (R-Ore.) for opposing the balanced-budget amendment, proponents of the measure responded to Greenspan's remarks by trying to draw him into the dispute.
"Have you said these things to Sen. Hatfield? Can we set up a meeting between the two of you?" asked Rep. Mike Parker (D-Miss.), a supporter of the balanced-budget amendment.
House Speaker Newt Gingrich (R-Ga.) also quickly agreed with Greenspan in laying blame for the dollar's crisis on the Senate vote. "The dollar has been sliding against the yen and the mark ever since the amendment went down," Gingrich said.
Greenspan said that defeat of the measure only increases the urgency for Congress to deal with deficit reduction and alter the long-term outlook for the American economy. "I think that if the (deficit) reduction is on a glide path (toward a balanced budget) and it is credible to the financial markets, I think we will see a marked reduction in long-term interest rates," Greenspan said.
But Greenspan also cautioned that Congress should avoid raising taxes to reduce the deficit, urging that virtually all of the reduction come through spending cuts.
"The rate of growth of government expenditures has exceeded the rate of growth of the tax base, so raising taxes to cover rising expenditures is simply not a policy choice we can use in the long run," he said.
Officials at both the Federal Reserve and the Treasury have been trying in recent days to convince Congress that the dollar's fall has been unrelated to the Administration's policies on Mexico. A senior Administration official said in an interview that the dollar's decline has much more to do with the long-term economic realignment between the United States, Japan and Germany than it does with the Mexican rescue plan.
In fact, aside from the mark and yen, the dollar has held up much better against most other major currencies. "If you talk to officials in Europe, they say the Mexican package is an insignificant issue in the markets there," the official noted.
Congressional critics charged that the dollar's plunge in the last week was spurred by fears that the Administration's $20-billion support package for Mexico has hamstrung U.S. ability to defend its currency.
Greenspan noted that his comments two weeks ago suggesting that the Fed had completed its yearlong series of rate hikes prompted a much bigger reaction in the markets than he anticipated.
Other observers have also said that his comments may have led some international investors to switch from dollars to German marks in anticipation of interest rate increases by the Bundesbank, the German central bank.
Those comments had been widely blamed as contributing to the dollar's plunge as global investors withdrew their funds from the United States, searching for better returns in Germany and other countries.
One reason that the dollar has been falling so fast is that the U.S. government has not stepped in to buy dollars in currency markets.
Higher interest rates in one country tend to bolster the value of that nation's currency, since the higher rates lure investors to buy the government's higher-yielding bonds.
Greenspan, however, appears unwilling to give in to growing pressure from the financial markets to raise U.S. interest rates to bolster the dollar's value. He and other Federal Reserve officials are reluctant to raise rates again merely to avoid a further disruption in the currency markets, because they fear that the higher rates could jeopardize the domestic recovery.
* DOLLAR FALLOUT: Strong yen threatens Japan. A U.S. company copes. D1
* QUESTIONS AND ANSWERS: What the dollar fall means. D3
* POLICY DILEMMA: Clinton Administration has few weapons to prop up dollar. D12