Currency `sterilization': the illusion of a stronger dollar

Central banks call it ``currency sterilization.'' It has nothing to do with cleaning up grimy greenbacks. Currency sterilization is more akin to a shell game. Here's how it works. Central banks want a stronger dollar. They buy dollars, thereby decreasing the supply and driving up the price that currency traders will pay for them. Voil`a, a higher dollar.

But what do the banks do with the dollars they've bought?

In the case of West Germany, the dollars were bought with marks. After the purchase, there are now many more marks on the market than the central bank, the Bundesbank, would like. Too many marks could mean higher inflation in Germany. So the Bundesbank sells some government securities and gathers in those extra marks. Now there are fewer dollars, fewer marks, and more government securities on the market.

In the United States, the Federal Reserve buys dollars using marks and yen and other currencies it has in its reserves. It might also borrow currencies from other central banks. But with fewer dollars on the market, interest rates would rise. The Fed doesn't want that, worrying about the impact on financial markets. So the Fed buys up Treasury bills. This puts the dollars back into circulation.

Economists say currency sterilization has little long-term effect. Like a shell game, it is forgotten soon after it is over.