Atlantic Exchange: Time for a New Dollar Diplomacy?

The request by the finance ministers of France and Germany yesterday to have the Bush administration address the falling value of the dollar was an exercise in managing the political expectations of French and German voters, said several currency analysts.

To European economic leaders, the falling dollar - especially against the euro - is at bottom a question of fairness. "Europe has until now assumed too much of the adjustment," said French Finance Minister Herve Gaymard.

After a meeting with his German counterpart, Hans Eichel, Mr. Gaymard said, "We have agreed that the imbalances at the origin of the structural fall of the dollar, the widening of the budget and current account deficits, persist." He then called on the Department of the Treasury to use all available measures to remedy the falling dollar situation. The French minister called on the G-7 nations to take up the issue at the February meeting of finance ministers in London, and to make "specific commitments" to remedy the problem.

The finance ministers' woes stem from the fact that a falling dollar has a disproportionately large effect on European economies. The lower dollar makes American products cheaper relative to goods manufactured in Europe. Moreover, much of the gross domestic product, or GDP, of the larger European states, especially France and Germany, is export driven. Thus French and German economic leaders see a drop in the dollar as endangering the modest recovery in GDP growth in France and Germany, the two largest economies in continental Europe.

Many market analysts took Mr. Gaymard's demand for "specific commitments" to be a thinly veiled demand for a coordinated currency intervention. What this means in practical terms is that the Federal Reserve would coordinate with the French and German central banks, as well as the bank of Japan and the Bank of England to boost the value of the dollar. This would be done by buying dollar denominated assets, such as bonds, to increase the value of the dollar. The central banks could also enter the currency markets and buy the dollar.

To currency analysts, however, there is a big problem with Mr. Gaymard's remedy: It doesn't seem to work. "You really aren't going to see a lot of examples of central bank interventions that have proved effective in increasing the value of a currency," said DeRosa Research and Trading president David DeRosa. "It's a pretty ridiculous practice, actually, since the market always takes the value of a currency back to where it was." Nonetheless, the Finance Ministers have to demonstrate to their constituents that action is being demanded, he said.

The Treasury Department in the 90s, under Secretaries Lloyd Bentsen and Robert E. Rubin, were particularly aggressive in coordinating currency actions in conjunction with European central banks. "It never worked, not once," said Mr. DeRosa, who noted that it cost taxpayers "hundreds of millions." Ironically, in May 1995, after the dollar hit a low versus French Franc and the Deutschemark after a failed intervention, it began what would be a five-year rise against the then major European currencies.

"Right after we stopped doing something, we got all we wanted and more," said Mr. DeRosa, as the dollar began to rise on the perception of better American economic fundamentals.

Even the thought of controlling the price of a currency is oxymoronic to Mr. DeRosa, who also teaches at the Yale School of Management. The dollar has dropped in price because of the massive financial needs of the American government right now, he said, and the sell-off in the dollar relative to the Euro is justified, if probably short-lived.

The problems of the America's budget deficit are real enough, and are justifiably reflected in the dollars $0.77 value against the 12-nation Euro, said a Wall Street economist on condition of anonymity. "But America's economic problems are much smaller than Europe's," which include "an aging population, a huge bureaucracy, massive welfare commitments and high-tax rates." Moreover, despite the dollar's woes, the economist said he and his colleagues think that within the next 18 months, it should bounce back to the $.85-$.88 range, based on American GDP growth expectations alone. "The American economic model is predicated on the expansion of growth, and over time, it has always turned the ship around."