The Plunging Dollar
DON'T sell the United States short!," proud Americans are likely to say to the nation's critics. But that's precisely what currency traders are doing with the US dollar. They're pushing greenbacks out the door.
The value of the dollar on world exchange markets, which has been slipping for some time, plunged within the last week, especially against the German mark. In midweek the dollar hit an all-time low against the mark.
What's going on? Is this another worrisome manifestation of "America's decline"? Or is it just a normal fluctuation in the price of a commodity, like pork bellies?
The immediate cause of the dollar's drop is the widening gap between short-term interest rates in the US and Germany. As Berlin's spending has soared to cover the costs of integrating the former East Germany, the nation's central bank is pursuing a stringent anti-inflation policy by keeping interest rates high.
Meanwhile the Federal Reserve has been easing US interest rates to stimulate the American economy out of recession. The resulting disparity in rates makes deutsche-mark investments more attractive than dollar investments; demand for marks is up, demand for dollars is down.
Some American economists regard the situation without concern. German interest rates will have to come down, they feel, as Germany's growth slows. In the meantime, the weakness of the dollar will boost US exports, as American products become cheaper relative to foreign products. Currency fluctuations are not a matter of national prestige, these economists admonish.
But other experts see cause for alarm. They believe that currency markets are responding to more than interest rates. The markets are passing judgment, they say, on America's longer-range economic strength. In particular, currency traders are worried about the US budget deficit and doubt that America's politicians are serious about grappling with it.
The weakness of the dollar poses a range of potential problems for the US. While it may stimulate exports, it makes imports more costly and could ignite inflation. The dollar's softness will deter foreign investment in the US; conversely, foreign investors may hasten to unload US holdings, driving down the value of assets from real estate to bonds. A capital flight from the US could even set off another stock-market crash as in 1987.
US policymakers won't raise interest rates during a slump - or an election year - so there's little they can do unilaterally to shore up the dollar. Washington will just try to slide through the mini-crisis, while jawboning Germany to lower its interest rates.