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TOP STORY As Dollar Weakens,
Paulson Faces Challenge
Of Tempering Its Decline
By MICHAEL M. PHILLIPS in Washington, JOANNA SLATER in New York and ALISTAIR MACDONALD in London
The dollar's continued slide against the euro and British pound highlights the delicate task faced by Treasury Secretary Henry Paulson: allowing the U.S. currency to weaken slowly against other currencies without sending it into a plunge that would damage the nation's economy.
Mr. Paulson has chosen to follow in the footsteps of his predecessor, John Snow, by acquiescing as markets pull the dollar lower. Yesterday, the dollar hit a 20-month low against the euro and a 14-year low against the pound. Over the past year, it has dropped 6.7% against a Federal Reserve index of seven major currencies.
Though Bush administration economic officials are eager to avoid a market-rattling crash, a weaker dollar could help the U.S. deflate its ballooning trade deficit by making American goods cheaper abroad and foreign goods pricier for Americans. It also could help Mr. Paulson fend off what he considers an alarming rise in protectionist sentiment.
"The Treasury cannot help but be pleased to see a gradual decline in the dollar," says Robert Hormats, vice chairman of Goldman Sachs International.
A Treasury spokeswoman refused to discuss the secretary's view of the dollar's recent movements, except to point to Mr. Paulson's repetition this week that "a strong dollar is clearly in our nation's interest, and I feel very good today about the strength of the U.S. economy."
Repeating that phrase, however, underscores the delicacy of Mr. Paulson's mission. Currency markets can respond instantly and forcefully when they sense a change in government policy or rhetoric. So even though Mr. Paulson has given no other hint that he wants the dollar to strengthen, he apparently feels obliged to repeat the strong-dollar mantra to avoid creating turmoil in the markets.
"It's very hard for the Treasury secretary to say anything about the dollar without getting into trouble," says Mr. Hormats. "It's very easy for him to do nothing about the dollar and stay out of trouble, and I think that's what they're going to do. You've got to talk the strong dollar -- and not do anything if the dollar weakens."
Frank Vargo, vice president for international economics at the National Association of Manufacturers, says the dollar's decline against the euro already is helping narrow the U.S. trade deficit with Europe in manufactured goods, which has grown wider every year for the past decade. NAM expects the gap to shrink to $95 billion this year, down from last year's $100 billion.
The narrowing also may have been caused at least in part by faster economic growth in Europe, which whets Europeans' appetite for U.S. goods, and slower growth in the U.S.
Major European currencies have been boosted lately by the strength of the region's economies and by market perceptions that European interest rates are more likely to keep rising than U.S. rates. Higher interest rates make a currency more attractive to investors because they provide a higher return.
In late New York trading yesterday, one euro bought $1.3244, up from $1.3146 Wednesday, continuing a rally that began last Friday when the European currency broke out of the $1.25 to $1.30 trading range it had occupied for about six months. The dollar has fallen more than 2% against the euro in the past week. The euro also has touched a new high against the Japanese yen.
Yesterday, the pound was lifted by news from British mortgage lender Nationwide Building Society that house prices in the United Kingdom rose 1.4% in November and are now up 9.6% for the year, their fastest growth since February 2005. The markets took that as a sign that the Bank of England might raise interest rates again as early as February. The pound surged to $1.9659 in late New York trading, up from $1.9449 late Wednesday and higher than at any time since September 1992, when it pulled out of the European Union's exchange-rate mechanism, the precursor of the euro.
Mr. Paulson has to tread carefully when it comes to the dollar, balancing competing domestic interests, the administration's own laissez-faire philosophy and the risk of a misstep that could roil financial markets. If he presses overtly for a broad decline in the dollar, he risks spooking financial markets and turning a gradual slide into a steep drop.
"Nobody wants a rout -- a disorderly, panicky decline in the dollar," says Princeton University economist Alan Blinder, a former vice chairman of the Federal Reserve Board. A sharp drop in the dollar probably would lead foreign investors, who lend heavily to the U.S., to demand much higher interest rates.
To fend off protectionist urges in Congress and hostility there toward China, Mr. Paulson has been lobbying Beijing to allow the yuan to rise and, by implication, the dollar to fall. U.S. manufacturers, their workers and their congressional representatives argue that China's policy of keeping its currency artificially weak gives Chinese products an unfair advantage in global markets.
Mr. Paulson is expected to renew his push for the Chinese government to relax its grip on the yuan when he leads a large, high-level U.S. delegation to China later this month.
"We want him to convince [China] to move" on its currency policy, says NAM's Mr. Vargo. "If it doesn't happen, you can believe there will be renewed efforts in Congress to pass legislation of some sort or other, and protectionism is going to rise."
The Chinese have been allowing the yuan to creep higher against the U.S. in the past few months, and the currency is now 5.7% stronger than it was in July 2005, when authorities initially allowed it to move.
Some strategists, meanwhile, expect downward pressure on the dollar against European currencies to persist for the rest of the year as worries about the vigor of the U.S. economy mount. Yesterday's U.S. economic data, particularly a weak reading on the Chicago purchasing-managers index and a report showing a jump in the nation's number of job seekers, contributed to the dollar's decline.
"The risks for U.S. economic data in the very near term are on the downside, with recent numbers suggesting the expected recovery will be postponed to the first quarter of next year. By contrast, European data continue to come in strong," says David Woo, head of global foreign-exchange strategy at Barclays Capital in London.
Grant Aldonas, who was undersecretary of commerce for international trade earlier in the Bush administration, predicts that the dollar's droop will persist. "I think Treasury would be glad to see that happen because it would be in line with economic fundamentals," he says.
Despite a call by French Finance Minister Thierry Breton for collective vigilance on the exchange-rate front, markets see little sign that global governments intend to intervene to arrest the dollar's slide. "To date there hasn't been any unified protest over the weakness of the dollar," says David Gilmore at Foreign Exchange Analytics, a consulting firm. "That is a green light to dollar sellers.
Joseph Quinlan, chief market strategist at Bank of America Corp., says a weaker dollar wouldn't be welcome everywhere. "Such a move would undercut the primary source of growth of many nations: exports" to the U.S, he wrote in a recent report to clients. "The world just isn't ready for a weaker U.S. dollar."
Seasonal factors may be contributing to dollar weakness, perhaps as European companies and investors sell dollars to repatriate profits. A research note from Barclays Capital says the dollar has fallen against the euro in the first two weeks of December every year since the euro's birth in 1999
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