What forces are affecting currency exchange rate?

The Outlook

September 24, 1995|By John E. Woodruff

AFTER SEEMING for more than a year to be in free-fall, the U.S. dollar gained more than 10 percent in value against the Japanese yen in less than two months, but last week, it gave back a big chunk of those gains over a few days. What's going on? Is the dollar's recent strength sustainable? What forces will work for and against it?

David Donabedian

Chief econimist, Mercantile Bankshares Corp.

The declines we've seen in the dollar in the last few days are basically a temporary correction to a real tear the U.S. dollar has been on over the last four months. If you look out over the next six to 12 months, the trend is going to be more strength for the dollar and more weakness for the yen.

What's driving exchange rates right now is what is going on in Japan, not what is going on in the United States.

Japan is going through a severe banking crisis. The government is being forced into major attempts to jump-start a dead economy.

The Japanese government has been forced into a complete reversal of fiscal policy. A country that was one of the most fiscally conservative in the world has been forced to resort to whopping deficit spending, with 10 fiscal stimulus packages in the past three years. They are fighting a rearguard action to prevent an outright deflationary cycle.

This is not a forecast for the next few days or the next week, but over time the dollar will not only work its way back up through the 100-yen level but will trade at or above the 110-yen level within the next six to 12 months.

Hung-gay Fung

Associate professor of finance, University of Baltimore

The recent strength of the dollar is a temporary thing. It was mainly due to interventions by the Bank of Japan, which has been very active in buying dollars to curtail the strength of the yen in an attempt to keep Japanese companies competitive. But today too many banks are holding too many dollars, and at the first negative signal there will be a big sell-off of dollars and a big drop in the value of the dollar. This could come at any time, and probably will come sooner rather than later, probably in the next few months.

So the dollar cannot be sustained at these levels for very long.

The fundamental forces that influence exchange rates -- deficit spending, relative productivity from one country to another, unemployment, trade deficits -- are mostly working in directions that hurt the dollar, with the exception of inflation, which will help to stabilize the dollar if it remains as tame as it has been recently. Stable U.S. prices will in fact help the dollar a lot. Also, Japan's economic problems right now may temporarily help the

dollar some.

Alfred G. Smith 3rd

Chief economist, NationsBank Corp.

The underlying force continues to be a basic imbalance between the U.S. and Japan. In Japan, they have a very large excess of savings over expenditures.

In the United States, we have a deficit in national savings, driven by the federal government's spending deficit. So fundamentally, the imbalance between the two countries works against the dollar and for the yen over longer periods of time.

Having said that, the dollar had become ridiculously undervalued over the last two years. Recently, with the impetus of Bank of Japan interventions, it has been able to regain its more natural value.

Even the Bank of Japan cannot go on doing that indefinitely, but they probably have not run out of means to do it for the time being.

Given the half-percent reduction of Japanese interest rates and the additional deficit spending the Japanese government announced this week, the dollar should be able to stabilize for a time somewhere not too far from where it is right now. It might even appreciate a little for the moment. But for the longer term, the only way to stabilize the dollar against the yen is to achieve a substantial reduction in the U.S. budget deficit.

Steve H. Hanke

Professor of Applied Economics, the Johns Hopkins University

You've had all the governments doing everything they possibly can to weaken the yen and strengthen the dollar, but this kind of action is futile in the long run.

Given the size of the U.S. trade deficit, all the dollars end up in Japan, where no one needs or wants them, and the Bank of

Japan has to serve as the dollar buyer of last resort in order to prevent a collapse.

A lot of people say that now, with the yen so strong, the trade deficit will rectify itself, and they are basically right. But they miss completely the fact that 10 other Asian countries all peg their currencies to the U.S. dollar, all run huge trade surpluses with the U.S., and all use the dollars they earn to pay for huge deficits they run with Japan. Their surpluses with the U.S. are going to grow far faster than Japan's surplus with the U.S. is going to shrink.

The end effect is that huge numbers of dollars are going to go on piling up in Japan, and over time the yen is going to get still stronger.

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