Drooping Dollar, Yeasty Yen

May 03, 1994

The Clinton administration's tendency to compartmentalize foreign policy -- moving in one area without calculating its effects elsewhere -- has led to major contradictions in its running trade dispute with Japan. For months, the U.S. has been putting the squeeze on Japan to open its markets by allowing the dollar to fall in value against the yen to near-record postwar lows. It did so in blithe disregard of the inflationary pressures this could cause domestically as foreign imports rise in price.

It is the fear of inflation, far more than upward nudges in short-term interest rates by the Federal Reserve Board, that has sent up long-term rates. These higher long-term rates have the administration in a tizzy out of concern they could disrupt a booming recovery that is considered political money in the bank for President Clinton's Democrats.

Too often administration goals are pursued with a kind of tunnel vision that ignores wider ramifications. Such was the case when Secretary of State Warren Christopher put human rights pressures on China just days before Washington was imploring Beijing to use its influence to checkmate North Korea's nuclear menace.

Even before the dollar's plunge last week forced Washington into a publicly acknowledged intervention to prop up the dollar, some economists were voicing concern over Special Trade Representative Mickey Kantor's in-your-face tactics with Japan. NationsBank's chief economist, Mickey D. Levy, told Fortune magazine: "The Clinton administration's threats of trade sanctions pushed down the dollar and added to risk premium that contributed to the rise in long-term interest rates."

Of course, there seems no accounting for the perversity of the financial markets. Fed chairman Alan Greenspan figured higher short-term rates, which he described as a pre-emptive strike on inflation, would hold down long-term rates and insure a healthy economy. Instead, long-term rates have risen. By the same token, the administration seems to have figured that American economic fundamentals were so strong -- a solid recovery with low inflation -- that the dollar would follow a firm path in international trading. Wrong again.

Why? Because investors had become convinced that the administration was content to let the dollar fall until Japan moved to stimulate demand for U.S. goods. But its government is too weak to move. And when dollars are dumped, foreign buyers can be lured to reverse course only through higher interest rates -- the exact opposite of what the White House wants.

Mr. Kantor did well last year in winning congressional approval of trade treaties. But his tough tactics with Japan could contribute to inflationary pressures, thus hindering his own administration's plans for a sustained domestic recovery.

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