October 18, 2007 / 9:35 PM / 13 years ago

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

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 this file photo a Filipino worker counts U.S. dollar bills inside a money changer in Manila February 27, 2006. 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. REUTERS/Romeo Ranoco

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.

“I think we have an ignore-the-dollar policy,” said Leo Melamed, chairman emeritus of the Chicago Mercantile Exchange.

“It’s laughable to say we have a strong-dollar policy,” said Melamed, who founded the world’s first market for financial futures. “When you have a current account deficit like we do, an interest rate factor that is moving downward, and the credit problems that the United States has, it really is difficult to say we have a strong-dollar policy,” he said.


The strong-dollar policy actually precedes Paulson and originated with Robert Rubin, who served as Treasury secretary under President Bill Clinton.

Rubin, in his book “In An Uncertain World,” said that a strong currency means “American consumers and businesses can buy imported goods and services more cheaply and that inflation and interest rates will tend to be lower.”

Yet, the dollar is on track to decline for the fifth year in six — a move that many economists agree is needed to help stop the widening U.S. current account deficit, which as a percentage of gross domestic product doubled in the last 20 years to around 6 percent.

Paulson even before he became Treasury secretary said publicly that the dollar would have to weaken to ameliorate the U.S. trade shortfall. So his maintaining a strong-dollar policy may reflect a more global perspective, that while a falling exchange rate value may be needed in the near term, the U.S. currency’s status as a dominant reserve currency remains in the country’s interest.

James Shapiro, senior managing director of Galileo Global Advisors, an international mergers and acquisitions consultancy, believes that the Treasury’s strong-dollar policy is meant to buffer what it views as an inevitable decline in the greenback, a fall that supports economic growth and has yet to cause much import price inflation.

“They don’t really have the ability or the desire to prevent the kinds of adjustments that have to occur to keep a macroeconomic balance going,” Shapiro said.

Economists believe that although central banks are in the midst of gradually diversifying their currency reserves away from the dollar, the weightings of dollar and euro reserves have largely stabilized at roughly 65 percent and 25 percent, respectively.

In that sense, the dollar remains “strong” as a reserve currency, Shapiro said.

Until the dollar’s decline sparks a significant rise in inflation, becomes disorderly so that companies do not have time to cope or triggers a flight from U.S. assets, the Treasury Department will likely work to keep its dollar policy strong and U.S. markets competitive.

As for the G7 meeting, Carl Weinberg, chief economist at High Frequency Economics, is not expecting any fireworks and certainly not any changes to the dollar policy.

“Nothing will come of this as long as no one is prepared to do anything that will affect the currency fundamentals,” he said.

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