Some Signs of an Upturn for the Dollar
After six years of stumbling against the euro, the dollar may be showing signs of getting back on its feet.
Two weeks ago, the dollar hit a new low of $1.60 for the euro amid expectations of lower interest rates in the United States and possibly higher rates in Europe. President Nicolas Sarkozy of France and other European leaders expressed alarm over the dollar’s decline and its devastating effect on Europe’s exports.
Since then, the dollar has strengthened — it closed at $1.55 Tuesday — and some economists say that even if it creeps down slightly, the dangers of a precipitous fall, at least against the euro, have subsided.
Economists point out that American policy makers, particularly Ben S. Bernanke, the Federal Reserve chairman, have begun to voice concern about the dollar’s fall and its inflationary effect in the United States, where a weak currency has increased the cost of oil and other imports for the American consumer.
“I am struck by Bernanke’s concern about prices when he talks about the dollar as a factor in inflation,” said Vincent Reinhart, a resident scholar at the American Enterprise Institute and former director of monetary affairs at the Federal Reserve. “The balance is shifting toward a little more concern about the dollar.”
Although many economists consider an all-out collapse of the dollar unlikely, they acknowledge that such a collapse could occur if overseas investors, fearing a relentless decline, start dumping dollars from their portfolios — accelerating exactly what they fear might happen.
While concerned about the dollar’s value against the euro, of course, the United States has taken the opposite approach toward China and some other Asian economies.
The Bush administration, for example, continues to press China to let its currency, the yuan, appreciate against the dollar. The yuan has already climbed more than 18 percent against the dollar since mid-2005, making Chinese goods more expensive in the United States.
That shift, in turn, has eased the clamor in Congress for trade sanctions against China.
But economists say any possible stabilizing of the dollar against the euro can be sustained only if there is a shift in economic fundamentals toward a recovery in the United States and a slowdown in Europe.
The dollar’s recent strength may be an anticipation of such trends. But it is also seen as a response to the Fed’s expected pause in interest rate cuts and to recent statements by financial officials from the major economic powers.
A major contributor to the recent trend is the signal from the Federal Reserve that after lowering interest rates slightly, it would pause before lowering rates further to avoid adding fuel to inflation. One reason the dollar had fallen is that money market investors have shifted to the euro in search of higher interest rates.
Economists said the Fed’s decision to indicate a pause in lowering interest rates was based not simply on its concern about inflation but also on worries over the dollar. The Fed, they said, did not want the dollar to plunge further — or to encourage even the remote possibility of dollar dumping by foreign investors.
“The decline of the dollar is a factor weighing on the Fed that makes them more reluctant to continue easing interest rates,” said Laurence Meyer, vice chairman of Macroeconomic Advisers and a former Fed governor.
Another factor in the dollar’s apparent stabilizing was a statement by finance ministers of the major industrial economies last month — little noticed by the public but carefully scrutinized by financial experts — indicating that the United States and its partners were not prepared to let the dollar plummet endlessly.
On April 11, the finance ministers of the United States, Canada, Japan and Europe said they were “concerned” about recent “sharp fluctuations in major currencies,” a statement widely seen as endorsing the possibility of an intervention by the United States Treasury and other finance ministries to prevent a steep drop in the dollar’s value.
Pressed to explain what the statement meant, Jean-Claude Trichet, president of the European Central Bank, said that “it’s a very touchy issue” but that the statement was “like a poem — it speaks for itself.”
In case it did not, perhaps, Prime Minister François Fillon of France told reporters last week that France was prepared to lead a “coordinated response” of major economic powers to relieve what he said were global currency imbalances, including an undervalued dollar.
Many economists say the statement of the finance ministers — all members of the Group of 7 nations — was an important factor in strengthening the dollar.
“The modest wording change in the G-7 statement was important,” said Peter Hooper, chief economist at Deutsche Bank Securities. “It reflected European concern about how far out of line the dollar was, and the United States not wanting to give the impression that they were totally disengaged on the dollar.”
Bush administration officials say that despite the G-7 statement, it would be anathema for them even to contemplate an intervention to keep the dollar from falling. Treasury Secretary Henry M. Paulson Jr. has repeatedly stated that currencies rise and fall depending on basic economic fundamentals and that interventions do not work.
But the fact that the American export sector is reaping the benefits of a lower-valued dollar, which is making American goods cheaper overseas, makes some people in Europe think that the administration has a policy of “benign neglect” on the dollar’s fall. In recent months, exports have surged 9.5 percent over their level a year ago.
The International Monetary Fund, which monitors currency fluctuations, has concluded that, given long-term trends, the euro and the dollar are in a state of equilibrium, whereas both the dollar and euro are overvalued related to the Chinese yuan, the Japanese yen and some other Asian currencies.
For many economists, the decline of the dollar against the euro or other currencies is more a function of the American trade deficit than its interest rate policies. In other words, as the United States imports more than it exports, businesses overseas pile up hundreds of billions of dollars that they sell when they convert to their own currencies.
“I think the dollar depreciates because of the fundamental trade imbalance,” said Martin Feldstein, professor of economics at Harvard. “Interest rates contribute to that in a small way, but the key driver is the $700 billion trade deficit.”
Mr. Feldstein said that as a result, he projects that the dollar may still have further to decline because, although the trade balance has narrowed recently, it is a long way from disappearing. “I think the dollar has substantially further to fall,” he said.
“Is this terrible? Not really. It’s the natural way for the trade deficit to be reduced.”