AN UNCERTAIN DOLLAR IS TURNING EYES TO JAPAN AND GERMANY
Is the dollar a prisoner of potentially damaging speculative excesses on foreign exchange markets? That's certainly a popular view on Wall Street. The financial markets have been spooked by fears that skittish currency traders would continue to push the dollar down against the German mark and the Japanese yen, thereby forcing U.S. bond rates higher and imperiling incipient recoveries overseas. Even the Clinton Administration, which once welcomed dollar weakness as a way to wring trade concessions from the Japanese, has given its blessing to efforts by the Federal Reserve and other central banks to support the dollar in currency markets.
According to economist Bruce Kasman of Morgan Guaranty Trust Co., the dollar's recent gyrations reflect more than nervous trading activity. What is happening, he says, "is a reassessment of international profit opportunities."
Kasman notes, for example, that the dollar has stayed strong against the currencies of most industrial countries except for Germany and Japan (chart). Given the robustness of the U.S. expansion, such strength is hardly surprising. Many industrial countries plagued by chronic economic woes have suffered currency depreciation against the dollar. And some--such as Britain, Australia, Canada, Norway, and Finland--have been aggressively cutting their interest rates.
Meanwhile, says Kasman, Germany and Japan have maintained far tighter monetary policies than the U.S., pushing inflation down and keeping real short-term interest rates relatively high at a time when comparable inflation-adjusted U.S. rates have been low. And both these nations are now poised for upturns in the face of significant idle capacity, whereas the U.S. expansion is rapidly--"too rapidly," says Kasman--approaching the point at which capacity constraints reignite inflation.
In short, Kasman believes that the message of the currency markets is that rising inflation risks in the U.S. are shifting investor interest toward the prospect of noninflationary profit growth in Japan and Germany. "We think the dollar should strengthen again," he says, "but only if the Fed acts more decisively to keep inflation in check."GENE KORETZ