A guide to what makes the dollar tick. BEHIND THE UPS AND DOWNS
The dollar hits new lows against the Japanese yen. The dollar rebounds as central banks intervene. These daily fluctuations, which often get reported on the nightly evening newscasts, are focusing attention on the United States currency. Here are some questions and answers on what the ups and downs mean. Why is the dollar important?
The dollar is the currency most often used in international commodity transactions to or from the US. It is also used in trade between third countries, and it is considered the reserve currency, meaning other countries that do not want to hold their own currency in case of an emergency, hold the US dollar.
What does it mean when we say the dollar is weak?
It means each dollar buys fewer units of another currency, such as the Japanese yen, or the West German mark.
It also has broader ramifications, since the dollar is often considered a barometer of the health of the US political and economic system. When there is a lot of confidence in the US, the dollar is frequently strong; when, confidence is waning, it is weak.
What decides whether the dollar is strong or weak?
One important factor is the difference in interest rates between the US and its trading partners. When US interest rates are higher, world investors will tend to buy dollars to take advantage of higher rates of return in the US.
Over the last half of 1987, US long-term government bonds have yielded 2.5 percentage points more than comparable West German bonds and 4.0 percentage points more than Japanese bonds. Included in these interest rate differentials are larger economic trends such as differences in inflation rates, and economic growth rates. Currency specialists also look at government spending and the size of trade surpluses or deficits.
Who decides currency relationships?
Currencies are traded on the open market at exchanges around the world. Buyers and sellers are often banks, brokerages, and corporations.
Central banks, however, such as the Federal Reserve Board in the US, and the Bundesbank in West Germany, can influence this direction by trading in currencies themselves.
How do the central banks do this?
The banks have reserves of foreign exchange that they can use to influence the market by buying or selling. They also have special relationships with other central banks, called ``swap lines,'' which permit them to borrow foreign currencies from each other.
How have the central banks tried to influence the direction of the dollar?
After a long period when the dollar had risen sharply in value, the major industrial nations in September 1985 decided the dollar had risen far enough. They met in New York and signed what is called the Plaza Accord, which essentially brought down the value of the dollar.
They met again last February in Paris and signed the Louvre accord, which sought to stabilize the value of the dollar, which had fallen sharply.
Why didn't this work?
It is not clear whether all the participants in the Louvre Accord really wanted the dollar to stabilize. Some people believe the US Treasury, for example, was glad to see the dollar fall in the hope it would help to even out the huge US trade deficit.
Is there a global danger to a falling dollar?
There is the danger that US exports will grow so fast that they will essentially export unemployment to other countries. This is why the US is pressing its trading partners to expand their own economies so their unemployment rates don't rise too fast.
The trade deficit is still large. Why hasn't the falling dollar helped?
It is beginning to have an impact. On a volume basis, US exports are increasing. But when the dollar falls, the value of those goods sold overseas appears smaller when translated back into dollars. Some people believe this racheting effect is keeping the trade deficit from improving.
Besides central-bank intervention, are there other ways to halt the dollar's fall?
Yes. Policymakers can raise interest rates in the US, or lower them abroad. Some economists believe further cuts in the US budget deficit will also help, because they would reduce the need for foreign financing of the deficit. Without foreign financing, the trade deficit would be lower, removing some of the selling pressure on the dollar.
Can ordinary citizens invest in foreign currencies?
Yes, but it can be expensive. Banks will sell you foreign currencies, but they add a 2 to 3 percent commission charge. There are other ways, such as buying mutual funds that invest in foreign stocks or bonds. But currency speculation is risky.