AS THE U.S. DOLLAR COLLAPSED against the German mark and the Japanese yen last week, Sara McBain saw the impact for herself in a supermarket in Tokyo. The housewife, visiting from Chicago, stared in disbelief at cranberry juice that cost nearly $7 a quart at the going exchange rate, some four times as much as a similar bottle would sell for back home. A large box of Cheerios cost more than $12. But it was the meat counter, she says, that “really threw me for a loop.” There she discovered roast beef for about $16 a quarter-pound. That made McBain wonder whether her husband, an advertising executive, should uproot their family and accept an offer from his company to transfer to Japan.
Half a world away, the sinking dollar had a very different impact on vacation-bound Germans. They jammed foreign-exchange counters from Bonn to Berlin in search of greenbacks to spend at U.S. destinations such as Disney World in Florida or ski resorts in Colorado. Latecomers found banks sold out of dollars and were advised to try again in several days. That was not good enough for determined folk in Munich, who roamed from bank to bank in the hope of laying hands on the suddenly scarce currency.
The scenes in Europe and Asia reflected the frenzy at trading desks everywhere as day after day the dollar and other currencies crashed to new lows. Before the panic abated, the once mighty American buck was worth little more than 88 yen and 1.36 marks (it fetched 238 yen and 2.94 marks in 1985); so far this year, the dollar has skidded 9% against both the yen and the mark. But the dollar’s troubles were only part of the turmoil: the British pound, the French franc and the Italian lira also tumbled, and the Mexican peso resumed its free fall until the country’s harsh new austerity plan led to a rebound. On top of that, governments were forced to devalue the Spanish peseta, the Portuguese escudo and the Brazilian real.
Above all, the slide of the dollar was symptomatic of a historic decline in its role. The dollar has been the world’s major reserve currency since World War II, meaning that other countries use it as a means of payment and hold it in their treasuries as a secure store of value. Such universal respect for the dollar has made it the linchpin of global finance and greatly enhanced American prestige abroad. But with foreign governments steadily dumping dollars to buy yen and deutsche marks over the past decade, the U.S. currency now accounts for only about 60% of the world’s reserve holdings, down from 70% in 1984.
This is far more than a dry, technical matter. As other countries flood the market with unwanted dollars, the declining value of the currency can raise the price Americans pay for foreign-made goods from cars to cameras and thereby heat up inflation. That in turn may force Washington to raise interest rates, jacking up the cost of loans and mortgages and holding the entire U.S. economy hostage to the currency’s problems. “We are gradually losing control of our own destiny,” Felix Rohatyn, a senior partner at the investment firm Lazard Freres, told Congress. Moreover, he says, “the dollar’s decline undercuts American economic leadership and prestige. It is perhaps the single most dangerous economic threat we will face in the long term because it puts us at the mercy of other countries.”
A weakening dollar clearly holds risks for the White House, where prospects of a “soft landing” after 48 months of economic growth offered some political hope. “It’s counterproductive for the Clinton Administration,” says Allen Sinai, chief global economist for Lehman Brothers. “It could lead to higher interest rates, provoking a recession by 1996-the worst possible scenario for the President. The danger,” he adds, “is that loss of control of the dollar will cause the Administration to lose control of the economy.”
Recognizing the hazard, the Treasury Department and the Federal Reserve made belated attempts to talk up the dollar last week, managing to halt its decline, at least for the moment. Declaring that “a strong dollar is in America’s national interest,” Treasury Secretary Robert Rubin pledged to preserve its status “as the world’s principal reserve currency.” Fed Chairman Alan Greenspan declared that a slumping U.S. currency was “unwelcome and troublesome,” a remark heard around the world as a warning that the Fed may again push interest rates higher, per-haps as early as its meeting on March 28.
Yet Greenspan was in effect leading with his chin–and currency traders knew it. After six rate hikes in 1994 and a seventh last month, the last thing the Fed chairman wants is to risk stalling the recovery and tipping the economy into a recession. “Using interest rates to lure foreign capital is like the way banks used to try to get depositors by offering toasters,” says economist and currency expert Judy Shelton. “It’s a straight enticement to get hot money, and it penalizes the people who need legitimate loans or mortgages for houses. It’s a terrible game, and I can’t see countries wanting to play it.”
For other experts, the wonder is that the dollar has fallen so far so fast, despite a vibrant economy that is more competitive now than at any other time in the past 30 years. U.S. growth is among the strongest in the industrial world, inflation has stayed below 3% for the past three years, and investors celebrated last month by sending the Dow Jones industrial average over 4000 for the first time ever. (The Dow closed at a record 4035.61 last week, after the Labor Department reported that unemployment fell from 5.7% to 5.4% in February.) Says German economist Rudolf Hickel: “Economists should concede that they simply can’t explain the fall of the dollar.” Yet there is no shortage of explanations for the current decline. They range from the political (the defeat of the balanced-budget amendment), to the diplomatic (a faltering Mexico could drag the U.S. down with it), to the seemingly intractable (America’s $65 billion trade deficit with Japan).
About one thing there is no disagreement: America’s budget and trade deficits have flooded the world with dollars, and the simple mechanics of supply and demand continue to put pressure on the dollar’s price. Indeed, with $600 billion of debt in the hands of foreigners, the U.S. is by far the world’s biggest borrower.
Such considerations put the dollar squarely in the sights of speculators, who have been dumping the currency on foreign-exchange markets and thereby driving down its value. According to the Wall Street Journal, the big winners have included billion-dollar hedge funds headed by such famed managers as George Soros and Julian Robertson; Robertson’s Tiger Management fund reportedly raked in some $150 million in 10 days of trading. Says Peter Morgan, an economist for Merrill Lynch in Tokyo: “There is a feeling that speculative forces are challenging the central banks just as they did in 1992,” when Britain was forced to devalue the pound.
Such speculation is difficult if not impossible to thwart because of the sheer size of the world’s foreign-exchange markets, which trade more than $1 trillion in currencies daily. Arrayed against that ocean of funds, the Federal Reserve and other central banks have only limited resources for use in any single intervention. Small wonder that when 18 governments pumped $5 billion into the markets to support the dollar two weeks ago, the effort had little impact. “The central banks are powerless against the currency-market forces,” asserts Gernot Nerb, director of research at the IFO Institute for Economic Research in Munich.
But if new rate hikes would harm the economy, and intervention won’t work, what can be done to strengthen the dollar? Some economists argue for doing nothing. “By a process of elimination, I come to the belief that a hands-off policy is best,” says Robert Hormats, vice chairman of the international division of Goldman Sachs. “If the Federal Reserve raised rates and it didn’t work, then they are really in a quandary” because the central bank would be under pressure to push rates even higher. Massachusetts Institute of Technology economist Rudiger Dornbusch concurs: “We should stop doing something every time something moves” and allow the dollar to find its own level. A cheap dollar helps U.S. exports by lowering their price in foreign markets, and that can improve the U.S. trade balance.
Whatever happens, many experts agree that the dollar must increasingly share the stage with the yen and the mark as a worldwide reserve currency. “There is little doubt that the dollar is in transition to a less dominant status in the global financial system,” says David Hale, senior economist for Kemper Financial Services, based in Chicago. Investment guru Jimmy Rogers likens the situation to the pound’s decline: “When sterling started losing its role as the world’s reserve currency, especially after the Second World War, there was a sterling crisis every year. It was a constant and ongoing thing. We are somewhere into that process now.”
Yet unlike postwar Britain, the U.S. can hardly be deemed an exhausted nation. While the dollar may undergo new gyrations, the U.S. remains the world’s largest economy. That fact alone should enable the dollar to hang onto a diminished but still important role as the leading currency among equals.
–Reported by Bernard Baumohl and Jane Van Tassel/New York, Edward W. Desmond and Satsuki Oba/Tokyo, Bruce Van Voorst/Bonn and Adam Zagorin/ Washington
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