The title of a story on the first Business Page of The New York Times on Wednesday, May 7 proclaims “Signs of Stability, Even Upturn, for Dollar” and it begins “After six years of stumbling against the euro, the dollar may be showing signs of getting back on its feet.” The chart included with the article, however, shows a small, almost imperceptible, upward blip in the dollar/euro exchange rate after a long slide (see chart below). Most notably, one could easily identify other points over the past seven years that, at the time, would be candidates for “signs of stability.” With today’s perspective, however, none of these marked the end of the decline in the dollar. Maybe this time will be different. But maybe not. The article concludes with Martin Feldstein’s observation that the persistent U.S. trade deficit may mean that the dollar “has substantially further to fall.”
There is a concern that a free fall of the dollar could ignite inflationary pressures in the US. But the weak dollar helps US exporters and US firms that compete with imports and, at a time when the Fed is cutting interest rates to spur the economy, a boost from the external sector may be welcome. And, whether or not the dollar decline is welcome, it may be necessary, given continuing external imbalances.
An article in the Financial Times on the day following the New York Times article, however, gives the impression that the dollar’s weakness is not welcome, at least among central banks. This front page article, entitled “US and Europe unite on dollar rise,” begins with the sentence “The US and Europe now have a united desire to see the dollar strengthen against the euro, senior officials have told the Financial Times.” What has been striking about this desire is the lack of financial deeds behind the words. In the past, dollar misalignments have been addressed with central bank interventions, often in a coordinated manner. For example, the dollar weakened by 10 percent in 1994 and then, in the Spring of 1995, began a precipitous plunge against the deutschemark and the yen. This eventually prompted rounds of coordinated intervention by eleven central banks at the end of May. Following this, the dollar rebounded and continued to strengthen through the summer and into the fall of 1995.
Why haven’t we seen central bank intervention this time around? Perhaps intervention is not that efficacious, especially when there are underlying fundamentals that suggest the dollar has further to fall. The interventions in the summer of 1995 may have been correlated with a rebound of the dollar because the precipitous decline preceding the policy actions did not seem to reflect underlying economic reality. The persistent US trade deficits, on the other hand, may require a continued dollar decline. And, knowing this, central bankers are unwilling to expend political capital (as well as their own funds) on an effort to lean against the wind.
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