The currency's resilience in the face of a slowing economy points to America's underlying financial strengths.
Conventional wisdom says that weakening domestic equity markets are supposed to pull a national currency down. Things get worse when a competing foreign economy is expecting an upswing. A declining interest rate at home also makes a currency less attractive.
All these things are happening right now in the US. Yet the dollar remains King Dollar. And the euro is certainly not enjoying the much predicted "year of the euro". Indeed, the world is witnessing a seeming paradox: America is the centre of an economic downturn yet its currency is coveted as a "safe haven".
Four factors do much to explain the dollar's feistiness. The first is the absence of American inflation. As recently as last November, the Federal Reserve maintained a tightening bias. This, as the recent spurt of interest rate cuts shows, was a mistake. American productivity growth has been higher, and less inflationary, than the Fed expected. The dollar has actually been deflating, at least when measured against many commodities. The gold price has fallen out of favour as a monetary measure. But the barbarous relic may be valid here. Had the Fed watched the gold price, which fell steadily from $290 an ounce last June to $260 this month, it might have cut rates sooner.
Other commodities have been sending deflationary signals. The prices of both industrial and precious metals and agricultural goods fell last year and continue to fall. While increasing energy prices obscured these drops, they were real. The core producer price index, which excludes food and energy, declined further in February than it had in any similar period in seven years. Markets recognise that the dollar can buy more than it could, and so want to hold more.
Secondly, the US government has signalled its willingness to take steps to ensure a strong dollar. Initially there was concern that Paul O'Neill, the Treasury secretary, would be non-committal about the dollar. But on January 17, Mr O'Neill indicated he would continue the Clinton administration's commitment to the currency, adding: "I can't believe that anyone would think to the contrary". This contrasts with the behaviour of, say, James Baker, Ronald Reagan's Treasury secretary, who was ambivalent about exchange rates.
The third reason is the Bush administration's push to increase America's relative competitiveness. Just a year ago, America was not deregulating. Indeed, the Justice Department was sending a loud pro-regulation signal with its prosecution of Microsoft. Tax cuts were not in the offing, although Germany was cutting taxes.
All this has changed. The Bush administration dislikes grand antitrust actions. Unlike Laurent Fabius, the French finance minister who recently disparaged "deregulation for deregulation's sake", the Bush administration values deregulation per se. President George W. Bush plans tax cuts, including cuts in top marginal rates. This signals an important change in fiscal direction.
Also important in increasing competitiveness is the Bush administration's attitude towards energy. The previous administration regarded energy supply as a matter for the government. When shortages emerged, President Bill Clinton tapped the nation's strategic reserves.
The Bush administration is different. It blames energy troubles on over-regulation at home. Instead of dictating policy from above, it is calling for deregulation.
Particularly important is the new willingness to open areas of Alaska to exploration. This is politically controversial. But the "drill away" approach sharply reduces the risk that America will suffer large-scale energy shortages in the longer term.
Another important signal for US competitiveness has been the country's willingness to allow "creative destruction" - to let companies lay off tens of thousands without intervention. There have been no calls for companies to slow their avalanche of layoffs, or even to take time to develop what may seem to be more socially palatable solutions. There is little talk of job sharing like Volkswagen or shorter working weeks a là France.
This tells the world that whatever ills America suffers it will work them out speedily; that, in the parlance of the trading floor, the US is "letting the market clear".
This position is in sharp contrast to Japan, which hid unemployment and spared banks for decades. At least for now, the old adage that "the business of America is business" holds true: America seems to be more business-oriented and less politically driven than Europe or Japan.
The fourth factor is the flipside of this American strength: an insufficiently strong Europe. As David Malpass, an economist at Bear Stearns, pointed out in a memo to clients on Friday, there are a number of reasons to be concerned about European growth.
The first is Germany, where the Ifo survey of business confidence fell by 1.7 percentage points in February, the eighth drop in nine months.
France is supposed to be doing well, but business sentiment there weakened last month, while consumer spending increased less than expected.
Of course, if Europe starts to flounder it will be partly the fault of the US - the US downturn is already showing signs of hurting continental economies. But Mr Malpass says another damaging fact-or has been the propensity of European leaders - particularly central bankers and finance ministers - to talk up prospects for growth. This increased the risk of markets being let down when reality set in.
King Dollar is not necessarily all good news, even for America: Mr Malpass is concerned that the US is pushing its trading partners in Latin America into a deflationary position. Still, it shows a universal truth: the currency of an economy that responds to trouble with alacrity is a currency that is likely to be in demand.
© Copyright 2001 Financial Times
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