Only five weeks ago, the Federal Reserve Board gave inflation a hefty one-two punch and strongly hinted that it was through raising interest rates for a few months.
Then the dollar briefly dipped below the all-but-metaphysical 100-yen level, world stock and bond markets swooned, politicians called news conferences, and yesterday, there was Fed Chairman Alan Greenspan, back before a congressional committee, saying the economy looks rosy and inflation is in check.
This time, however, Mr. Greenspan declined to even discuss whether the Fed will raise interest rates -- for a fifth time this year -- this time to defend the dollar.
Why the flap? Compared with many earlier plunges -- the dollar had fallen from 360 yen in the 1970s to 102 by last week -- this week's blip down to 15-hundredths of a yen under 100 will scarcely affect the cost of a Toyota to an American or a trip to America for a Japanese.
"In fact there is no world currency crisis, but there is something about going below 100 yen to the dollar that politicians just don't like, and perhaps it was made a bit spookier by the simultaneous drops against European currencies, even though in reality the dollar today is worth more German marks than in 1992," Paul Boltz, chief economist for T. Rowe Price Associates Inc., said yesterday.
What spooks politicians creates uncertainty, and uncertainty spooks investors.
So when the dollar began to slide last week, investors demanded higher interest rates on long-term bonds, and the higher rates sucked money out of stocks, driving the Dow Jones industrial average and other indexes down with the dollar.
Some analysts have a name for this kind of jump in interest rates: the "uncertainty premium."
It was partly to knock a hefty uncertainty premium out of the mar
kets that the Fed took its fourth and hardest shot at inflation on May 17.
Markets responded. Long-term interest rates eased, and stock prices worked upward for four weeks.
Until the dollar headed down again last week. But the uncertainty premium crept back. Market analysts began to speculate publicly that the Fed might be forced to raise interest rates to defend the dollar by drawing investors away from foreign currencies. Politicians reasoned that a weak dollar would mean higher U.S. prices for Japanese cars, opening the way to inflation by giving U.S. makers room to raise prices.
"By this week, you actually had unnamed people at the Fed telling newspapers the Fed might have to raise interest rates again after all, in order to support the dollar, which only made the Fed's problem worse," Mr. Boltz said.
Long-term interest rates went up, stock prices down. Yesterday, even after rebounding, the Dow Jones industrial average had surrendered virtually all of its four-week gain over five days of trading.
Will the Fed actually raise interest rates to defend the dollar?
"My experience with the Fed suggests that they are very unlikely to raise interest rates to defend the dollar," said Alfred G. Smith III, chief economist for NationsBank.
Then what can be done if the dollar falls below 100 yen again tomorrow?
Not much, most economists believe.
"The Fed can join other governments in an intervention, buying up dollars by the billions to push the price up, but in exchange markets where trillions are traded daily, it will have absolutely zero lasting impact," said Charles McMillion, president of Washington-based MBG Information Services, an economic consulting firm.
"When central banks intervene, they start by trading away hundreds of millions or billions of dollars in the strong currency and end by holding huge amounts of the weak currency, which then sooner or later finds a lower level despite the intervention," T. Rowe Price's Mr. Boltz said.
"You can see what it costs them in the fact that just one speculator, George Soros, is reputed to have made $600 million or more when the Bank of England tried to keep the European currency agreement intact," he said.
The Fed joined the Bank of Japan in just such an intervention when the dollar fell near 100 yen early in May, and currency traders responded by bidding the dollar back up to 108 yen -- for a while.
The effect of that intervention faded in the past few days.
"What is driving the fall of the dollar is the U.S. trade deficit witJapan, and that is a powerful long-term force. Realistically, the dollar probably actually needs to fall some against the yen," said NationsBank's Mr. Smith.
But what about the effect on U.S. inflation?
Looking back to the 1980s, when there were marked changes in the dollar-yen relationship, Mr. Smith said that he found "no evidence of any correlation between a weakening dollar and U.S. inflation."