Bush and Paulson boxed in corner on dollar mantra

By David Lawder - Analysis

LONDON (Reuters) - Bush administration officials are increasingly finding themselves having to defend U.S. economic policies to foreign leaders who are battling inflation and pointing fingers at the weak dollar.

U.S. Treasury Secretary Henry Paulson's "strong dollar" mantra is sounding rather hollow, with the greenback under pressure in recent weeks as markets have trimmed expectations for U.S. borrowing costs to be raised further.

The adjusted rate expectations reflect the Fed's challenge in balancing a slowing U.S. economy with rising inflation pressures -- due mainly to rampant oil prices.

The dollar has been in retreat against the euro since mid-June, hitting a 2-month low earlier on Thursday beyond $1.59 -- close to the single currency's record high of $1.6018 -- before ECB President Jean-Claude Trichet struck a less aggressive note than expected on the prospects for further euro area interest rate hikes. It then recovered some two cents to around $1.5720

But the dollar is still down 5.2 pct on its index against a basket of currencies, and down 7.75 pct against the euro on the year to date.

Paulson has been taking most of the heat in recent weeks but Secretary of State Condoleezza Rice and President George W. Bush himself are now having to answer for the dollar's weakness.

Chinese Premier Wen Jiabao told Rice on Monday that the United States should stabilize the dollar, state television said, using more pointed language than earlier this year when he said he was concerned about the dollar's sustained depreciation.

Paulson, in Russia, Germany in Britain this week, heard various concerns about the dollar's value, including from a group of Russian businessmen -- even though Russia's trade with the United States only matches its trade with Finland.

Two days after meeting with Paulson to discuss trade and investment, Russia's new president, Dmitry Medvedev, said Russia wanted to see "a stable, not weak, dollar".

In Europe, political leaders are putting inflation at the top of their agendas. British Finance Minister Alistair Darling in a joint news conference with Paulson on Thursday said it was important that "we don't allow inflation to become entrenched into our system as we saw 20, 30 even 10 years ago."

But with European rates possibly rising further and the U.S. Federal Reserve holding rates at low levels, there is little more that Paulson can do but try to talk up the dollar and try to shore up U.S. growth.

"I don't see the U.S. engaging in any kind of grand scheme to coordinate action across the globe to strengthen the value of the dollar," said Andrew Busch, global foreign exchange strategist with BMO Capital Markets in Chicago.

"Paulson realizes it's almost impossible to do this without the U.S. being able to raise interest rates at the same time the Europeans are raising interest rates," Busch said

For his part, Paulson continues to repeat his longstanding view that a strong dollar is in the United States' interest and that its value ultimately will reflect bright longer-term prospects for the U.S. economy even if America is going through a difficult time right now.

According to his logic, Bush administration policies such as distributing more than $100 billion in tax rebates to consumers, preventing home foreclosures, and regulatory changes aimed at resolving the credit crisis will underpin the dollar by putting the economy back on track.