Reverse Spin in Dollar Policy

May 06, 1994

The administration has come full circle in its rhetoric on the value of the dollar.

President Clinton and Treasury Secretary Lloyd Bentsen were all for talking down the dollar when they first came to office -- this as a device to pry open Japanese markets to U.S. exports. Now, with world investor confidence in U.S. policies and competence at a low ebb, they had to organize one of the largest currency rescue operations in history this week to keep the dollar from going through the floor.

It may seem bizarre that the dollar is weak and the German mark is strong when economic fundamentals in both countries would suggest the opposite. The U.S. is in the midst of a robust recovery and its interest rates are trending upward; Germany is bogged down in recession and its interest rates are going down.

Moreover, the political fundamentals in both countries would hardly imply diametrically opposite currency movements. While the Clinton administration is going through tough times with Whitewater, personal scandals, foreign policy embarrassments and uncertainty about health care reform, Germany is in an election year that may put the Social Democrats in power -- hardly a development the financial markets will welcome.

Secretary Bentsen expressed his thoughts on this anomaly when he declared Wednesday that "this administration sees no advantage in an undervalued currency" -- a remarkable statement designed to convince the markets that the administration is determined to stabilize the dollar.

Mr. Bentsen won a temporary respite yesterday as the dollar inched upward. But we believe the markets will remain skeptical until the Federal Reserve Board increases short-term rates to about 4.5 percent. Its three quarter-point moves boosting short-term rates from 3 percent to 3 3/4 percent have succeeded only in having the markets anticipate further shoes dropping. Long-term rates have kept climbing, reflecting doubts the administration really backs Fed moves to control inflation.

Interest rate increases on a scale almost certain to slow economic growth would displease election-minded Democrats. Yet anything less would leave the dollar weak and the need for further costly interventions both inevitable and of doubtful efficacy. Central banks are not in business to be popular, which is one reason why they should be protected from political interference. As Michael Bruno, chief economist of the World Bank, put it last week, a central bank "is the way society protects itself from itself."

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