The world’s currencies rapidly are dividing up into winners and losers, and right now, the U.S. dollar is on the losing team.
Along with the Mexican peso, the Italian lira and others, the dollar is being deserted by nervous investors who want safe places to park their money. In the aftermath of the peso’s collapse, they are looking for countries with strong, stable governments and tough anti-inflation policies. Once, that would have led them to the dollar; today, they are buying German marks, Swiss francs and Japanese yen instead.
“People are fleeing to quality,” said David Wyss, senior economist at DRI/McGraw-Hill, a Lexington, Mass., forecasting firm.
A lower dollar has one key advantage: It makes U.S. goods cheaper on world markets. That could boost exports and help extend the current economic expansion. But there are problems, too. The dollar’s fall makes imported goods more expensive, which could lead to higher inflation and higher interest rates. It also makes it harder to attract the foreign investors needed to help finance the nation’s $200 billion budget deficit.
The dollar’s reputation as a safe bet has been hurt by a variety of concerns: that the U.S. economy is linked too tightly to Mexico’s troubled economy; that the Federal Reserve is not sufficiently tough on inflation; and that the United States continues to run big trade and budget deficits.
The result has been a free-fall for the greenback that has roiled financial markets and increased the possibility that the Federal Reserve will have to raise interest rates. Higher rates ease fears of inflation and lure foreign investment.
“I don’t think this will end until the Fed does something decisive,” said Michael Perelstein, head of international investing for the New York firm McKay Shields.
The dollar hit a postwar low of 92.70 yen Monday, a drop of roughly 6 percent since the beginning of the year. Over the same time, the dollar has dropped 8 percent against the German mark.
The dollar’s plunge came even after the Fed and other central banks intervened in financial markets last week to buy dollars. And it came even after Treasury Secretary Robert Rubin said the U.S. wanted a strong currency.
The dollar has plenty of company. The Mexican peso hit a new low Monday. Late Sunday night, European finance ministers agreed to a devaluation of the Spanish peseta and the Portuguese escudo. The Italian lira and the Canadian dollar have also been under pressure.
What has put investors on edge? In a word, Mexico. The unexpected meltdown of the peso has forced money managers to look at the world in a new light. In effect, they are asking: If it could happen in Mexico, where else could it happen?
The immediate answer was other Latin American countries and chronically weak countries like Italy, which run large budget deficits. Countries with big deficits depend on the steady flow of international money to pay their bills.
Now it seems to be America’s turn for a re-evaluation. “Investors are afraid that the U.S. has gotten into bed with a country - Mexico - that could pull us down,” said Allen Sinai, chief economist at Lehman Brothers, a New York investment firm.
The Clinton administration’s decision to bail out Mexico is viewed as an open-ended pledge to a country in deep trouble. Money mangers fear the United States will have to spend more than the $20 billion already committed to restore confidence in the Mexican economy. Some analysts also worry that the weak Mexican economy will cut down on American exports to that country, widening the United States’ already large trade deficit.
In some circles, Alan Greenspan is considered part of the problem. Two weeks ago the Federal Reserve chairman hinted to Congress that the Fed may be done raising interest rates. Over the past year the Fed has raised rates seven times to slow the economy and keep inflation in check. “Outside the U.S. the feeling is it is premature for the Fed to be talking like that,” said Perelstein. Higher interest rates make currency more attractive to foreign investors.
The rest of Washington comes in for its share of criticism, too. Economists say investors were disappointed by last week’s defeat of the balanced budget amendment. And the Clinton administration has regularly been accused of secretly wanting to see the dollar fall to boost American exports overseas.
Ask investors what they want to see in a country, and the answer is a description of Germany. “Investors want a place with a reputation for conservative economic management,” said Frederick Breimyer, chief economist at State Street Bank.
Germany’s inflation rate was actually higher than the United States’ last year, but the country’s central bank, the Bundesbank, is considered among the world’s toughest in battling inflation. The German economy is in an earlier stage of recovery than the U.S. economy, which means there is more room to grow without triggering inflation. East Germany, which just a few years ago was looked upon as a Mexican-style disaster, is today looked upon as an economic success story.
A sharply rising currency is a mixed blessing for countries like Germany and Japan. By boosting prices of exported goods, a strong currency can slow economic growth.