Down And Down the Dollar Goes

By John Greenwald

European tourists flocked to tony U.S. stores last week, snapping up bargains. Shoppers like Pirrera Enza, a bank worker from Sicily, stocked up on perfumes and cosmetics at Bloomingdale's in New York City for less than half their price at home. Enza flew back a few days later with a planeload of beaming compatriots toting bags and luggage bulging with American-bought goods.

What made the bonanza possible was the U.S. dollar's plunge to its lowest level since World War II. But that same decline meant that while the Europeans frolicked, Americans abroad turned into window shoppers because the cost of everything had become so expensive. "A room in a decent hotel costs $450, and breakfast $35," fumed Robert McFadden, an Atlanta lawyer in London. "It would have been bad enough without the dollar's fall. Now it's just outrageous." Said Stephanie Bressler, a recent college graduate from Rhode Island who was touring Paris with friends: "Like we saw the Louvre, the outside of the Louvre, but we couldn't go inside." Neither Bressler nor her companions could afford the $7 admission charge.

Welcome once again to the wild and wacky world of foreign exchange crises. After several years when major Western currencies generally moved in unison on international exchanges like pennants gently fluttering in the breeze, the dollar in recent days has looked as though it was about to be blown off its flagpole. The American currency dropped a dizzying 4% against the German mark in a four-day slump that leveled off in the middle of last week. In the 1960s, when the dollar was king of currencies, it was worth 4 marks; by a year ago, it was still worth more than 1.7 marks. But last week the value of the dollar was down to just 1.4 marks.

The dollar slump and the ripple effect felt by other currencies staggered stock and bond markets around the world. Business and consumer confidence, already shaky, suffered another setback. Investors watched helplessly as early in the week stock prices sank and long-term interest rates turned upward, depressing investments and driving up mortgages and other borrowing costs. "Rising rates and a falling dollar -- that's the definition of a currency crisis," says C. Fred Bergsten, director of the Institute for International Economics in Washington. "What it says is that foreigners are pulling out of both U.S. currency and financial markets."

The cheap dollar, or any cheap currency, offers both advantages and disadvantages. It all depends on where you stand. American manufacturers generally like a lower dollar because it slashes the cost of their products overseas and thus helps exports. For example, Ford expects the low exchange rate to boost sales of its new right-hand-drive compact, the Probe, which it plans to ship to Japan. A cheap dollar, however, increases inflation because U.S. consumers have to pay more for such foreign goods as Louis Vuitton luggage or Hermes scarves. A declining currency is also seen as a vote of no- confidence by foreign investors in a country's economy -- and in the people managing it.

A cheap currency is likewise a mixed blessing for foreign countries. For Japanese and European manufacturers, a weak dollar hurts sales of goods like cameras and cars because it raises their prices in the U.S. But foreign tourists in the U.S. can suddenly buy a lot more with their marks, yen or francs.

While business people last week were trying to get used to new exchange rates, the currency crisis jolted political capitals from Bonn to Tokyo. The dollar's fall was a clear embarrassment to President George Bush and his re- election campaign. The sharpest plunge came in the two days after Bush's much touted acceptance speech to the Republican National Convention. The money markets seemed to be sending the message that they saw little in his proposals for jump-starting the U.S. economy. A wobbly dollar will make it harder for Bush to brag during the campaign about the strong U.S. presence around the world.

The international currency instability left many European countries in similar binds. While Britain, France and Italy would like to cut interest rates to stimulate growth, the European Monetary System obliges them to keep their currencies from falling too far behind the mark. "It is the economics of the madhouse, but we have agreed to play by the rules," says Peter Morgan, director general of the London-based Institute of Directors, an international organization of corporate board members. "The danger is that if we stick by the rules, the recession continues even longer."

The currency chaos compounds the uncertainty over the outcome of the September 20 referendum in France on the Maastricht treaty, which is supposed to lay the basis for a European Union. French voters could decide they do not like the high interest rates dictated by Germany and vote non on the treaty. That would doom it and change the shape of post-cold war Europe.

The cause of the flight from the dollar is a fundamental disagreement between the German central bank and the Bush Administration and the Federal Reserve. The Germans have been pushing interest rates up in an attempt to fight domestic inflation brought on by the absorption of the former East Germany. The costly unification has raised the annual inflation rate to about 4%, a low level for most countries but an uncomfortable one by German standards. German central bankers are willing to accept less growth in return for less inflation.

The Bush Administration and the Federal Reserve, on the other hand, are fighting a totally different war. The Federal Reserve, under not-so-subtle pressure from the White House, has been pushing interest rates down for more than a year in hopes of stimulating the U.S. economy out of its long bout of sluggish growth in order to help the President's re-election campaign.

With German rates high and American ones low, a yawning interest-rate gap exists between the two countries. Investors put their money in countries that pay the most interest, and right now German banks are paying about 6.5% more than U.S. ones. Result: the international savvy money has been flowing out of dollars and into marks. "What is happening now is absolutely logical," says economist Barry Bosworth of the Brookings Institution in Washington. "The only puzzle in my mind is why it took so long for it to happen."

As companies, consumers and tourists scramble to cope with volatile money rates, the dollar's slide could continue to resonate in the U.S. election-year fray. Supporters of presidential nominee Bill Clinton recognize political fodder. "This is not a campaign issue in the sense that it has a major impact on the voter directly," says Gene Sperling, economic policy director for the Clinton campaign. "But it provides background music that gives legitimacy to the instinctive feeling that people have given up on the current policies of this Administration."

Bush aides blame the falling dollar on the Bundesbank's relentless policy of raising rates and forgetting about the rest of the world. Administration officials point out that Washington has been urging the German central bank to bring down rates for more than a year. Such jawboning, however, has failed to budge the staunchly independent Bundesbank.

The Bush Administration has the sympathy of the government of Chancellor Helmut Kohl. Tired of being portrayed as the bad guys on the international monetary scene, German officials would also like to see their interest rates fall. "Bonn is definitely not happy about the policy the Bundesbank pursues," says Jurgen Pfister, head of economic research at the Commerzbank. "But the government would harm itself if it criticized the Bundesbank too overtly. The majority of the public still thinks stability is the main goal."

The real problem is that there is little to stop the dollar from sliding or the mark from climbing as long as government and financial leaders pursue conflicting goals. "What you have in Europe is policy gridlock," says James O'Neill, head of financial-markets research for Swiss Bank Corp. in London. "The Bundesbank is performing a domestically mandated task that has provoked increasing irritation around the Continent. No one has a ready solution, and until one is found, financial markets will remain in turmoil."

In a world where almost all the major countries are suffering through either slow growth or no growth, the last thing international business needs is a period of new instability and currency crises, which would only inhibit new growth. Yet the combination of economic stagnation and low interest rates in the U.S. and high interest rates in Germany remains a prescription for monetary disarray and instability. Until the Americans and Germans can stop pushing and pulling their economic policies in opposite directions and narrow the interest-rate gap through policies that are good for both of them -- and for the rest of the world -- businesses, consumers and even those happy tourists buying bargains will continue to watch currencies gyrate.

CHART: NOT AVAILABLE

CREDIT: [TMFONT 1 d #666666 d {Source: DRI/McGraw-Hill}]CAPTION: DMs per dollar

- Interest rates

With reporting by Daniel Benjamin/Berlin, S.C. Gwynne/Washington and Adam Zagorin/Brussels