Doctor the Dollar? Depends How Sick
The dollar has fallen 9.5% against major currencies since Henry Paulson became Treasury secretary 16 months ago. His response has been to repeat the mantra that a "strong dollar is in our nation's interest." What would it take to make Mr. Paulson and Federal Reserve Chairman Ben Bernanke, who has seen the dollar fall 11% since he took office in February 2006, respond to the dollar's drop? And what could they do?. The government hasn't many options if it wanted to arrest the decline. It could use stronger rhetoric to talk up the dollar. It could, in coordination with other countries troubled by the dollar decline, buy dollars in foreign-exchange markets. Or the Fed could raise interest rates, since money flows to countries with higher rates.
Neither the Bush administration nor the Fed has shown any inclination toward any of those, preferring instead to let market forces operate. In testimony before Congress last week, Mr. Bernanke said he remains "optimistic" that current U.S. economic conditions "will lead to a sound dollar in the medium term."
No wise government ever flatly rules out intervening in currency markets under any circumstances, but economists and former government officials say the U.S. is likely to step in only if the dollar's fall becomes so precipitous and disorderly that it unsettles financial markets or sets off a flight out of dollar assets, especially if China, Japan or oil producers were to dump their large dollar holdings or if it makes it difficult for the Federal Reserve to cut interest rates to boost the economy. While the dollar has sunk to record lows against other major currencies, most notably the euro, the decline has been gradual.
When Weakness Aids Strength
As long as it doesn't become a rout, a weaker dollar is a big help to the economy, making U.S. exports more attractive at a time when consumer spending at home is slowing down and housing is a drag. Trade accounted for a full percentage point of the third quarter's 3.9% growth, and exports are buoying profits of many big U.S. companies.
In contrast to the Treasury in President George H. W. Bush's administration, which was a frequent player in currency markets, this Bush administration has been hands-off. The U.S. last intervened in 2000, during the Clinton administration, to help prop up the euro. Its last move to boost the dollar was made by the Clinton Treasury in August 1995, when the currency was falling even as the Fed raised rates.
"It's a very high hurdle for this administration because it hasn't done any intervention. They are philosophically not oriented towards intervening in markets," said Edwin Truman, a former Fed and Treasury official now at the Peterson Institute for International Economics, a Washington think tank.
'Too Far, Too Fast'
What would change that? "They would have to believe there was a contagion from the foreign-exchange market to other markets and that it would be desirable to send a message to the markets that they're taking things too far, too fast," Mr. Truman said.
Many economists see government intervention as ineffective, largely because the markets are so large that governments can't really influence them -- outside of tightly controlled currencies like China's. Others say it can help bring markets to their senses if, as markets tend to do, they overshoot.
Another option is to use words to try to drive the dollar. Former Treasury Secretary Robert Rubin perfected the art of repeating the same strong-dollar message, and so not jiggling the markets -- until he wanted to. In 1997, he modified the statement from "a strong dollar is in the U.S. interest" by adding "and the dollar has been strong for some time now." That signaled the U.S. view that the dollar's rise had gone far enough.
If Mr. Paulson decided to try such "verbal intervention" or "jawboning," choosing the right words would be tricky. Signaling displeasure with the dollar's level on currency markets and then doing nothing to back up the words could diminish his credibility and hurt his ability to use rhetoric effectively if the dollar's decline turned steep.
Any message would have to be calibrated to convey concern that the markets may have pushed the euro too high too fast -- a view increasingly widespread among European politicians -- without giving aid and comfort to those in the Chinese government who are reluctant to let markets push up the value of the yuan.
It is unclear what stronger rhetoric would accomplish. "There is very little Treasury can do," said Harvard economist Kenneth Rogoff. "Their influence over the dollar is very minimal."
The Fed could have a big impact if it lifted interest rates or signaled that no more rate cuts are likely, despite a slowing economy. But that requires "figuring out at what point would a dollar freefall sharply endanger their [Fed officials'] goals for growth and inflation," said Mr. Rogoff.
The Fed rarely talks explicitly about dollar weakness, leaving public commentary to the Treasury -- the tradition in the U.S. But the dollar's weakness is clearly a factor in Fed thinking and, on balance, could contribute to reluctance to lower interest rates even in a weakening economy.
'Talk Is Cheap'
Joseph Quinlan, chief market strategist at Bank of America in New York, said the markets aren't hankering for intervention and instead want to see the Fed continue to fight inflation. "Talk is cheap," Mr. Quinlan said. "I think what the Fed needs to do is maintain its inflation-fighting credentials, and the Treasury Department needs to keep the protectionist tide on Capitol Hill at bay."
Nadeem Walji, manager of New York hedge fund Duma Capital Partners LP, has been betting against the dollar, buying "put" options that would permit him to sell the dollar at an above-market price if it continues to fall. "Once the Fed cut, that was the beginning of the end," said Mr. Walji, because lower U.S. interest rates made the dollar less desirable.
Pressure From Europe
Pressure on the U.S. to intervene could rise in Europe, where the weaker dollar is hurting exporters by forcing them to choose between raising the dollar price on what they sell in the U.S. or accepting fewer euros for their products.
The European Central Bank hasn't yet grown concerned enough about the euro's strength to cut rates, instead holding them steady. But the soaring euro clearly is on the mind of policy makers. ECB President Jean-Claude Trichet last week called its record move to more than $1.47 "sharp and abrupt," adding that "brutal moves are never welcome."
Mr. Truman cautions that the U.S. government can't hide behind a "strong dollar" mantra if things deteriorate. "The Treasury and Federal Reserve have to be careful not to be perceived as cheerleaders for the dollar's decline and not be perceived by the markets as practicing benign neglect," he said.
Neither the Bush administration nor the Fed has shown any inclination toward any of those, preferring instead to let market forces operate. In testimony before Congress last week, Mr. Bernanke said he remains "optimistic" that current U.S. economic conditions "will lead to a sound dollar in the medium term."
No wise government ever flatly rules out intervening in currency markets under any circumstances, but economists and former government officials say the U.S. is likely to step in only if the dollar's fall becomes so precipitous and disorderly that it unsettles financial markets or sets off a flight out of dollar assets, especially if China, Japan or oil producers were to dump their large dollar holdings or if it makes it difficult for the Federal Reserve to cut interest rates to boost the economy. While the dollar has sunk to record lows against other major currencies, most notably the euro, the decline has been gradual.
When Weakness Aids Strength
As long as it doesn't become a rout, a weaker dollar is a big help to the economy, making U.S. exports more attractive at a time when consumer spending at home is slowing down and housing is a drag. Trade accounted for a full percentage point of the third quarter's 3.9% growth, and exports are buoying profits of many big U.S. companies.
In contrast to the Treasury in President George H. W. Bush's administration, which was a frequent player in currency markets, this Bush administration has been hands-off. The U.S. last intervened in 2000, during the Clinton administration, to help prop up the euro. Its last move to boost the dollar was made by the Clinton Treasury in August 1995, when the currency was falling even as the Fed raised rates.
"It's a very high hurdle for this administration because it hasn't done any intervention. They are philosophically not oriented towards intervening in markets," said Edwin Truman, a former Fed and Treasury official now at the Peterson Institute for International Economics, a Washington think tank.
'Too Far, Too Fast'
What would change that? "They would have to believe there was a contagion from the foreign-exchange market to other markets and that it would be desirable to send a message to the markets that they're taking things too far, too fast," Mr. Truman said.
Many economists see government intervention as ineffective, largely because the markets are so large that governments can't really influence them -- outside of tightly controlled currencies like China's. Others say it can help bring markets to their senses if, as markets tend to do, they overshoot.
Another option is to use words to try to drive the dollar. Former Treasury Secretary Robert Rubin perfected the art of repeating the same strong-dollar message, and so not jiggling the markets -- until he wanted to. In 1997, he modified the statement from "a strong dollar is in the U.S. interest" by adding "and the dollar has been strong for some time now." That signaled the U.S. view that the dollar's rise had gone far enough.
If Mr. Paulson decided to try such "verbal intervention" or "jawboning," choosing the right words would be tricky. Signaling displeasure with the dollar's level on currency markets and then doing nothing to back up the words could diminish his credibility and hurt his ability to use rhetoric effectively if the dollar's decline turned steep.
Any message would have to be calibrated to convey concern that the markets may have pushed the euro too high too fast -- a view increasingly widespread among European politicians -- without giving aid and comfort to those in the Chinese government who are reluctant to let markets push up the value of the yuan.
It is unclear what stronger rhetoric would accomplish. "There is very little Treasury can do," said Harvard economist Kenneth Rogoff. "Their influence over the dollar is very minimal."
The Fed could have a big impact if it lifted interest rates or signaled that no more rate cuts are likely, despite a slowing economy. But that requires "figuring out at what point would a dollar freefall sharply endanger their [Fed officials'] goals for growth and inflation," said Mr. Rogoff.
The Fed rarely talks explicitly about dollar weakness, leaving public commentary to the Treasury -- the tradition in the U.S. But the dollar's weakness is clearly a factor in Fed thinking and, on balance, could contribute to reluctance to lower interest rates even in a weakening economy.
'Talk Is Cheap'
Joseph Quinlan, chief market strategist at Bank of America in New York, said the markets aren't hankering for intervention and instead want to see the Fed continue to fight inflation. "Talk is cheap," Mr. Quinlan said. "I think what the Fed needs to do is maintain its inflation-fighting credentials, and the Treasury Department needs to keep the protectionist tide on Capitol Hill at bay."
Nadeem Walji, manager of New York hedge fund Duma Capital Partners LP, has been betting against the dollar, buying "put" options that would permit him to sell the dollar at an above-market price if it continues to fall. "Once the Fed cut, that was the beginning of the end," said Mr. Walji, because lower U.S. interest rates made the dollar less desirable.
Pressure From Europe
Pressure on the U.S. to intervene could rise in Europe, where the weaker dollar is hurting exporters by forcing them to choose between raising the dollar price on what they sell in the U.S. or accepting fewer euros for their products.
The European Central Bank hasn't yet grown concerned enough about the euro's strength to cut rates, instead holding them steady. But the soaring euro clearly is on the mind of policy makers. ECB President Jean-Claude Trichet last week called its record move to more than $1.47 "sharp and abrupt," adding that "brutal moves are never welcome."
Mr. Truman cautions that the U.S. government can't hide behind a "strong dollar" mantra if things deteriorate. "The Treasury and Federal Reserve have to be careful not to be perceived as cheerleaders for the dollar's decline and not be perceived by the markets as practicing benign neglect," he said.
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