A Penny for Your Yen

June 22, 1994

For at least 12 minutes yesterday on the New York financial markets, a U.S. penny was worth less than a Japanese yen -- the first time this once-unthinkable phenomenon had occurred in modern history. It was a dramatic reflection of churning foreign exchange rates that are driving down the value of the dollar, puncturing an overpriced stock market, pushing up commodity prices and perhaps forcing the Federal Reserve to increase short-term interest rates once again.

Unlike the Fed's earlier boosts in interest rates this year, this one (if it comes) would be defensive rather than preemptive. In other words, it would be a reaction to world market pressures driving up long-term rates in contrast to previous moves designed to head off a threatened return of inflation.

The Clinton administration is predictably on the spot. It can send the Treasury Department on a dollar-buying spree to prop up the greenback, as it did a month ago only to win a few weeks' respite. Or it can acquiesce once again in another upward nudge in short-term rates, knowing this could slow the recovery without any assurance that any of these government moves can prevail against the overwhelming force of the financial markets.

As for critics of the Fed, such as Maryland's Paul S. Sarbanes, they will have to reconsider their earlier assumptions that U.S. central bankers were unnecessarily raising interest rates when fears of inflation were mere will-o'-the-wisp. The official U.S. basket of commodity prices is up 20 percent over lows earlier this year. Oil is in the $17-a-dollar range, up $4 from January levels. Gold, ever the hedge against inflation, is soaring in price.

Trade figures yesterday also incited market jitters as the U.S. deficit widened despite the drooping dollar. This might have reflected the strength of the U.S. economy, which is moving along nicely at a growth rate of close to 4 percent. But the trade figures also fueled speculation that the dollar is still in search of a low as the markets test the nerve and commitment of major industrial nations.

While the loss of hundreds of billions of dollars this year in the stated value of assets worldwide is troubling to many investors and speculators, to say nothing of politicians whose fate is in their hands, it should be realized that equity prices rose to unrealistic levels in 1993 as a result of unusually low interest rates. The search is now on for a new equilibrium. If the fundamentals of the U.S. economy are as strong as we think they are after the shakeout of the last recession, there is reason to hope the nation will come through this period of turmoil in fairly good shape.

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