Other than "I love you" and "You're under arrest," few three-word English phrases have as much significance as "strong dollar policy."
The strong-dollar mantra seemingly served the country very well in the latter half of the 1990s, although lately it has become something of an albatross. While the Bush administration probably would prefer a softer dollar, which would help U.S. exporters, it can't publicly abandon the so-called strong dollar policy without risking a run on the currency, if not an outright crash.
"With a $500 billion-a-year current account deficit, you're forced to have a strong dollar policy," said David Gilmore, a partner at Foreign Exchange Analytics. "If you suddenly say 'we want a weaker dollar,' you'll get there in a hurry and it's going to feed on itself. You may end up with a vortex of dollar selling."
Even a far less-dramatic statement can have destabilizing effects, as Treasury Secretary John Snow learned last week, when an impromptu comment helped knock the dollar to a four-year low vs. the euro. By Friday, currency traders were moving on to other issues, such as the weak employment number, and the Dollar Index ended at its lowest level since October 1999. But the flak over Snow's comment that he's "not particularly concerned about" the recent decline in the dollar still reverberates.
Given that the dollar's value is a key barometer of the nation's economic and financial health, a couple of questions arise: Don't economic fundamentals matter far more than any policy statement? And, what exactly is the 'strong dollar policy,' and are we stuck with it?
The answer to the former question is fairly easy: "Words don't mean anything," said Edward Leamer, director of the Anderson School of Business at UCLA. "What matters is what Mr. Greenspan does with interest rates and Mr. Bush with the federal deficit. Those are the only things coming out of Washington that materially affect the value of the dollar."
Certainly, Japan's experience shows the folly of policy statements and even outright intervention, as the country has repeatedly failed to stem its rising yen.
To many observers, rising trade and federal budget deficits here, combined with slowing economic growth and opposition to U.S. foreign policy, mean dollar weakness is inevitable, regardless of what policymakers say. The U.S. reported a record $435.2 billion trade deficit in 2002, and record-setting budget deficits above $300 billion are projected for fiscal 2003 and 2004, even excluding the cost of any war with Iraq.
The answer to the latter question is murkier.
Slogan Makes History, Moves Markets
In hindsight, the "strong dollar policy" is something of a misnomer, and a burr under the Bush administration's saddle.
"A strong dollar is in the national interest" was first uttered by then-Treasury Secretary Robert Rubin in 1995. To the exclusion of almost anything else, Rubin incessantly repeated the phrase during the remainder of his tenure. Successor Larry Summers duly picked up the mantra.
The dollar was far weaker in 1995, during which it hit post-World War II lows vs. the yen and German mark. Rubin's comments were a rhetorical extension of the
repeated efforts from 1994 through August 1995 to intervene in currency markets and strengthen the dollar, often with support of other central banks. Recent weakness notwithstanding, the dollar is far stronger today, a huge impediment to U.S. exporters.
After some intervention to support the dollar in the early days of Rubin's tenure at Treasury, the U.S. intervened to
the greenback vs. the yen in 1998 and the euro in 2000.
Rubin "never said a rate of any currency to associate with
the strong dollar policy, never defined it at all beyond saying it," recalled Lara Rhame, senior economist at Brown Brothers Harriman. "To that extent, when you say 'what is it?' it's just the repetition of those words, and nothing else."
But those words had, and still have, meaning -- at least to short-term currency traders. The strong dollar policy came about when memories were still fresh of Lloyd Bentsen's "benign neglect" of the dollar and a depreciation strategy under Ronald Reagan's Treasury Secretary James Baker, unveiled at the Plaza Accord in September 1985. Baker's strategy led to sustained dollar weakness, ultimately contributing to the October 1987 stock market crash.
Some observers worry about a possible repeat in the current environment. An accelerated decline in the dollar likely would be "concurrent with the literal crash of U.S. equities," said Rhame. (She isn't forecasting such a cataclysm, but many hard-core bears do.)
Since early 2001, there's been a very high correlation between the
and the Dollar Index. In part that's because foreign investors are selling the trillions of U.S. assets they gobbled up in the 1990s; holdings that are suffering even more than yours when currency translations are accounted for.
There has been no mass exodus by foreign investors, as some doomsayers prophesize, but direct foreign investment in the U.S. fell 45% last year to $46 billion. Furthermore, U.S. direct investment abroad exceeded foreigners' investment here for the first time since 1995,
The New York Times
A weaker dollar also would cause higher prices for imported goods and likely drive Treasury rates higher, affecting bond funds and mortgage rates alike. It also would greatly hamper Japan's efforts to export its way out of prolonged economic contraction. Given all that, "there's no chance in hell the Bush administration is going to abandon the language of a 'strong dollar policy,'" Gilmore said.
But some believe they've already abandoned it, or at least tried to modify it, which is almost as bad.
To many, Snow's comments
last Tuesday were eerily similar to those of his immediate predecessor. Paul O'Neill was viewed as a maverick, and Snow was supposed to bring more discipline to the secretary's role as chief spokesman for the dollar. But last week's comments had some wondering if maybe O'Neill was merely doing the White House's bidding in trying to (not so) subtly undermine the dollar, and Snow was picking up the beat.
Most currency watchers disagreed with that assessment, preferring to give Snow the benefit of the doubt. Snow's "comments are meaningless
because there's no policy associated with the mantra," said David Greenwald, a principal at Scalene Partners, a currency-focused hedge fund.
However, the bottom line is that currency traders import meaning to the mantra. The inescapable fact is O'Neill, Snow, former White House economic adviser Larry Lindsey (and others) veered away from the "strong dollar" mantra to varying degrees. Bush administration officials often have added something akin to "sound, pro-growth economic policies and
a commitment to free and open markets
are the foundation for a strong dollar," as Snow said during his Senate confirmation hearing in January. (Italics added.)
Such statements reveal the philosophical problem the politically conservative administration has with a policy that implies the threat of intervention.
In most instances, administration officials were compelled to clarify their statements as the dollar weakened, usually resulting in a terse reiteration of support for the strong dollar, as Snow offered Wednesday. The need for clarifications reveals the foreign exchange market's hypersensitivity to any perceived change in U.S. policy.
"If we tell foreigners 'we don't believe in defending the currency,' they sell. But between the lines, the attitude is an orderly decline is acceptable," Gilmore said.
But as the Bush administration is discovering, it's very hard to have it both ways.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.