Dollar's Descent Has Currency Watchers on Edge
By Paul Blustein
Washington Post Staff Writer
Friday, May 9, 2003; Page E01
A long slide by the dollar has turned into a rout in recent days, providing a new competitive edge to American manufacturers but arousing worries about potential instability in the global financial system.
Against the euro in particular, the U.S. currency's descent is gathering extraordinary speed. Late yesterday the exchange rate for one euro surged to $1.15, the highest level for the 12-nation European currency since January 1999, the month it began trading. As recently as April 29, rate was $1.09 per euro.
The plunge against the euro comes as the dollar is losing ground against other major currencies as well. The U.S. currency hit a 51/2-year low against the Canadian dollar this week, and it fell yesterday morning to a 10-month low of 116.01 Japanese yen per dollar before recovering late in the afternoon to 116.88. As is always the case for big currency moves, the dollar's weakness has both benefits and costs. It helps American industry compete with foreign firms by making U.S.-made goods cheaper on world markets, and that should eventually help shrink the massive U.S. trade deficit. But a tumble in the dollar risks getting out of hand by prompting foreign investors to dump their holdings of U.S. stocks and bonds, which could drive interest rates up and choke off U.S. economic growth.
"If it falls a moderate amount, that's a welcome correction," said Kenneth Rogoff, the chief economist at the International Monetary Fund, who has long viewed the dollar as overvalued because of the size of the trade gap. "But if it falls too precipitously, that could certainly create problems." Of particular concern, he said, is that a sudden drop in the dollar's value "might lay bare weaknesses in the financial system" by inflicting severe losses on major market players that have engaged in complex trades and hedging strategies, some of which may depend on a stronger or more stable greenback.
Although the dollar has fallen rapidly on other occasions without triggering financial disaster, "one could liken it to diving off a cliff into water," Rogoff said. "If there's enough water below, it's fine, but it's a risk every time you take one of those big dives."
Desmond Lachman, resident fellow at the American Enterprise Institute, agreed that the dollar's decline "is generally a healthy development" but said "what gives pause now is that it looks like this process is gathering momentum. If we get the dollar declining in a disorderly fashion, and it becomes self-fulfilling, people will move money out of the States in a way that could be very disruptive to U.S. financial markets."
The reasons for the dollar's fall are clear: As a country that imports far more than it exports, the United States needs huge amounts of investment from abroad to balance the scales -- roughly $500 billion a year. But persuading investors to put their funds in the United States has become increasingly difficult because yields in many overseas markets are higher than they are in this country.
The result, a shift from U.S. securities to foreign ones, lowers the value of the dollar. That has become much more pronounced in recent days, in part because markets have perceived that the Federal Reserve is more likely to lower interest rates in coming months than other central banks, the European Central Bank in particular.
The ECB announced yesterday that it was holding its benchmark rate unchanged at 2.5 percent, which is double the U.S. federal funds rate. Wim Duisenberg, the ECB president, indicated that he shares some of Fed Chairman Alan Greenspan's concern about deflation -- a decline in the general price level -- but he suggested he wasn't worried nearly as much about it. With the end of the war in Iraq, "risks to growth have diminished," he said, a comment that traders interpreted as reducing the chances for an ECB rate cut in the near future.
The resultant drop in the dollar was an additional source of delight to Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers, an organization that has long complained that the dollar's excessive strength is hurting American industry. "We're very pleased to see the currencies move the way they have, especially the euro and the Canadian dollar," he said.
The dollar, Vargo said, was "most overvalued" in February 2002, when it peaked at about 30 percent above the October 1997 level based on a Fed index of many currencies. "Today it's down to 10 percent over the 1997 level, so we've recovered two-thirds of the damage," he said.
The manufacturers group still believes that major Asian countries, notably Japan and China, keep their currencies artificially low to spur exports. Indeed, Japanese Finance Ministry officials warned yesterday that the recent rise in the yen has been too fast, and that they would take "firm action" to keep the currency from strengthening further. They disclosed that the government had secretly sold $20.4 billion worth of yen in the first three months of the year in an effort to brake the yen's rise.
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