Markets see U.S. policy of "ignore the dollar"

By Kevin Plumberg - Analysis

NEW YORK (Reuters) - The U.S. government's adherence to the "strong-dollar" mantra, even as the currency plumbs record lows against the euro, has made markets skeptical that a finger will be lifted to stop a broad decline.

In all likelihood, the U.S. Treasury will not step in to save the dollar any time soon and the Bush administration may be the first since the gold standard was dropped in 1971 to not intervene in the currency market. In fact, the Treasury has not stepped into the currency market since September 2000, when it helped prop up the euro.

But the intention of the strong-dollar policy may be changing under current U.S. Treasury Secretary Henry Paulson to refer to the dollar's dominant role as a reserve currency and its significant place in an increasingly global marketplace.

On the eve of a Group of Seven rich nations meeting, the dollar dropped to an all-time low against a basket of major currencies, pushing the euro above $1.43 for the first time ever -- about 48 hours after Paulson reiterated that a strong dollar is in the interest of the United States.

After weakening 8 percent in 2006, the dollar has fallen another 7 percent so far this year, mostly because of expectations that the Federal Reserve will have to lower borrowing costs further to stave off an economic recession.

On the one hand, the dollar's downward march seems in line with one of Paulson's oft-repeated phrases: that exchange rates should be set in competitive markets based on fundamentals.

So, if the U.S. economy is showing signs of weakness, particularly because of its ailing housing sector, then the greenback should weaken relative to other currencies with more stable economies.

However, the insistence on saying a strong dollar is best for the U.S. economy -- when it is falling -- leaves many market participants scratching their heads.