(4 of 4)
As Greenspan strives to curb prices, he will have to watch for trouble in currency markets. A further steep decline in the value of the dollar could fan inflation, since it would cause new increases in the cost of imports. Greenspan apparently hopes to avoid that by allowing a modest rise in U.S. interest rates, which will make dollar-denominated securities more attractive to foreign investors.
The danger is that other major nations, particularly West Germany and Japan, will raise their interest rates along with the U.S. The Japanese economy has been growing at a 4% rate over the past six months, and could face ! inflationary pressures. The West Germans, traditionally fearful of even a whiff of inflation, might boost interest rates to guard against price rises. If many countries tighten up at the same time, the dollar will be no less vulnerable than it is now.
Defending the dollar and restraining inflation will take resolve and courage on the part of the Fed, especially in an election year. But Greenspan can probably muster the necessary determination if he thinks back to the early 1980s, when inflation got completely out of control and it took 20% interest rates to halt the price spiral. No one -- Republican or Democrat -- wants to experience a repeat of that episode.