A Strong Dollar: Is It Friend or Foe?

The dollar is once more the strongman of major world currencies, and it flexed again on Tuesday--soaring to 121.15 Japanese yen in New York, up from 119.47 on Monday and the highest level in nearly four years.

But while the dollar’s streak against the yen, the German mark and other key currencies is gaining increasing attention, whether it’s good, bad or irrelevant in the context of the global economy is a matter of great debate.

A rising dollar, some experts contend, threatens to undermine U.S. corporate competitiveness, create a bitter new trade dispute with Japan and spark a fresh wave of volatility in all major world currencies, with potentially dire consequences for stock and bond markets.

Yet, in the eyes of Federal Reserve Board Chairman Alan Greenspan, the strong dollar is a friend: It means Americans should pay less for imported products, thereby putting downward pressure on the U.S. inflation rate--and, perhaps, delaying the day the Fed will feel the need to tighten credit to keep inflation at bay.

And within the Clinton administration, the strong dollar is apparently now viewed as quite desirable, a status symbol of the American economy’s health.

Of course, this is the same Japan-bashing administration that argued for a weaker dollar in the spring of 1995, helping to hammer the currency to under 80 yen.

Then, as now, the dollar’s direction sparked predictions of a potential crisis for the world economy and markets. None developed then, however. And so, not surprisingly, some economists are questioning whether the worry being generated by the dollar’s current surge is overblown.

“It’s nothing to ignore, but [the dollar’s latest move] is well within the range of what [it] has done in the 1990s,” says Stephen Roach, economist at Morgan Stanley & Co.

What’s more, he notes that the buck isn’t rising universally: It has been very strong versus the yen, the German mark and the Swiss franc over the last year. But the dollar’s value has either declined or barely budged in the same period versus the currencies of Canada, Mexico and Britain--three key U.S. trading partners.

Why has the dollar rocketed against the yen and the mark in particular? Logically, economists would say that a healthier economy should boast a stronger currency, because it should be attracting more investment, and it should be generating a higher level of confidence among investors to hold assets denominated in that currency.

Given that the U.S. economy is, by many measures, in far better shape than either Japan’s or Germany’s, it shouldn’t come as a shock that the dollar would be gaining strength versus the yen and mark.

Interest rate levels also can play a decisive role in determining currency values. Because U.S. bond yields are higher than Japanese and German yields, global investors looking to earn decent returns should, theoretically, favor U.S. bonds. To buy U.S. bonds (or any U.S. asset), you first need to buy dollars.

But what constitutes a fair value for the dollar compared with other currencies--in other words, how much of a rise is “enough”? Economists try to answer that using various formulas, often not agreeing.

What troubles economists more than anything, however, is when a currency appears to be gaining momentum for the simple reason that the global army of currency speculators--within banks, brokerages and independent money management firms--has decided to pile on, hoping to profit from the trend.

U.S., German and Japanese policymakers may have had good reason to support a gradually rising dollar in 1996. With the U.S. economy in excellent shape, a stronger dollar gave a needed boost to Japanese and German exporters, helping to underpin those economies when domestic consumption was weak.

But recent statements by U.S. Treasury Secretary Robert Rubin in further support of a healthy dollar are inviting big trouble, argues Robert Brusca, economist at Nikko Securities in New York.

Speculators, he said, have reacted like sharks just tossed chum, setting off a feeding frenzy for the dollar that is continuing. Yet the benefits that would normally be associated with a stronger dollar--aggressive foreign buying of U.S. Treasury bonds, for example--have either been absent or have been overwhelmed by bond dumping by domestic investors. Indeed, U.S. bond yields have risen to four-month highs in recent weeks, even as the dollar has surged.

What that suggests, analysts say, is that rather than jump into U.S. assets to benefit from the rising dollar, many foreign investors are staying away--perhaps because they fear a fast reversal in the currency.

What has many economists worried now: A rising dollar naturally hurts many U.S. companies, by giving foreign competitors a pricing advantage here and abroad. If the dollar is strong and U.S. interest rates are rising, stocks could suffer a double whammy.

On the flip side, if the dollar’s momentum suddenly reverses--and it plunges in value--foreign owners of U.S. Treasury bonds could be compelled to bail out and take their assets home again, rather than see them devalued by a sinking dollar.

Morgan Stanley’s Roach doesn’t think the latter nightmare scenario is likely, any more than previously predicted dollar-fueled disasters came to pass. But as foreigners’ ownership share of U.S. bonds has continued to soar in recent years, Roach concedes that currency-induced risks are greater than they were.

Another looming worry is that the United States and Japan could be poised for a brutal trade fight, if the dollar continues to rise and swells Japan’s trade surplus. Washington could demand new Japanese steps to boost consumption and curb exports--which the Japanese are likely to resist, Brusca says.

The simple way around trouble, of course, would be for the dollar to stabilize soon. Governments have successfully reined in speculators before. We’ll find out soon whether the United States and its G7 major trading partners now think they need to do exactly that: G7 finance ministers will meet next week.

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Liftoff for the Buck

The dollar continues to surge against the Japanese yen, reaching 121.15 yen on Tuesday, the highest since early-1993. Monthly closes and latest:

Jan. 1994: 108.49

Tuesday: 121.15

Source: Bloomberg News

Dollar’s Mixed Bag

The dollar has surged over the past 13 months against some currencies, notably the Japanese yen. But against others--including those of key U.S. trading partners Canada, Mexico and Britain--the dollar is actually weaker or up only marginally.

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Per dollar: Pctg. Currency 12/31/95 Tues. change Swiss franc 1.156 1.429 +23.6% Japanese yen 102.67 121.15 +18.0 German mark 1.438 1.649 +14.7 French franc 4.915 5.560 +13.1 Brazilian real 0.971 1.044 +7.5 Italian lira 1,585 1,616 +2.0 Mexican peso 7.690 7.810 +1.6 Hong Kong dollar 7.733 7.742 +0.1 Canadian dollar 1.362 1.340 -1.6 British pound 0.647 0.618 -4.5

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Source: Times reports