No Way To Rescue The Greenback And No Need ToRudi Dornbusch
The dollar has reached all-time lows against the Japanese yen and the German mark. But don't worry: Reports of the greenback's demise have been vastly exaggerated. There is nothing that can be done--or needs to be done.
Despite large swings, the dollar has been declining against the yen and the mark for more than 25 years. Japan and Germany have performed better than the U.S. on productivity and inflation during that time, and they have taken a more conservative fiscal stance: Hence the steady appreciation of their currencies against the buck. Added to this have been the growing indebtedness of the U.S. and the rising net-creditor status of Japan and Germany.
This is not the first time the dollar has seemed to slip into a bottomless hole. Of course, the dollar won't plunge an extra 20% or 30%, as though it were the lira or the peso. The extent of the dollar's decline so far, however, is not surprising.
ASPIRIN POWER. Why is a falling dollar no big deal? The dollar has not really dropped so far--in trade-weighted terms, the depreciation has been barely 3.5% since December, 1994--and there have been large offsets to the weakness against the yen and mark. The Canadian and Mexican currencies have both depreciated against the dollar. The trade effects are muted on Germany because most of its trade is with Europe or in competition with Japan in developing markets. And as for Japan, the yen's appreciation has kept a rival producer at bay. The upshot is that not much has happened--for growth or inflation--and certainly not enough to divert interest-rate policy from its primary responsibility, which is price stability with steady growth.
Whenever key currencies move sharply, hard-money gurus demand a return to the gold standard, and more moderate reformers call for a "new Bretton Woods." We don't need gold, thank you. The past decade bears witness that central banks around the world are taking inflation seriously. In the U.S. particularly, fighting inflation before it strikes--like taking an aspirin before you get a headache--does wonders for monetary-policy performance. Likewise, a new Bretton Woods agreement--on fixed rates and common monetary policy--just isn't an option, even if it were a good idea. Since the Europeans can't keep their currencies fixed, there's no reason to think a North Atlantic fix is workable.
A more moderate option for stabilizing currencies is coordinated intervention: Get into the currency market with strength and inflict deep wounds on speculators by throwing billions at them. The notion of a new coordinated-intervention agreement, like the 1985 Plaza and Louvre accords, is just a pipe dream. Unless central banks enlist interest-rate policy to support their intervention, drawing lines in the sand won't work.
True, there is evidence that intervention alone may have at least short-lived effects, particularly if it hits an uncertain market late in the afternoon with all central banks standing firm when exchange rates have gone wild. But none of these conditions are met today. More likely, we will see Brussels eager to get its hands once again on European monetary issues, now that its initiative on a common currency is on the rocks. No surprise it seizes on the dollar: To a man with a hammer, everything looks like a nail.
Is all this too complacent? Won't U.S. inflation rise? Won't Japan and Germany collapse under the weight of appreciation? Won't central banks dump the trillions of dollar-denominated assets they have traditionally held? Germany can cope well, but the same is not true of Japan, where such concerns are amply justified. Its anemic economy stumbles from one recession to another, with reprieves only from projects such as public works following an earthquake.
BIG BUBA? Japan's strong yen may be driven by its trade surpluses, but that is hardly a cure, since the weakening of the economy reduces the level of imports even faster than the loss of competitiveness raises them. Japan needs a cut in interest rates--down to zero--to cope with pervasive bankruptcy and slack. Fed Chairman Alan Greenspan's driving short-term rates down to 3% cured the U.S. economy. Japan's dead-in-the-water economy with falling prices needs some of the same medicine.
Don't worry about the dollar losing its status. That alarm rings every time the currency slides. Soon, the dollar will take an upturn, and people will be happy they did not jump ship. Over time, the greenback has had rivals as a reserve currency, but we are nowhere near a time when the world wants to entrust all its assets to Japan's Finance Ministry or even to the Bundesbank.