Summers Isn't the Strong Dollar's Enemy, Despite Appearances

The slump in the dollar makes traders' fears about the new Treasury secretary seem valid, but they only seem that way.
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The Summers of our discontent? Hardly. But forgive the market if it sometimes thinks so.

The hallmark of

Robert Rubin's

tenure as

Treasury

secretary was his strong-dollar policy. A departure from the dollar bashing of his predecessor,

Lloyd Bentsen

, Rubin's commitment to the greenback helped draw foreign capital to the U.S. and keep inflation low.

So there was some concern when

Lawrence Summers

took over the post in early July. Investors remembered that before the advent of Rubin, Summers had sometimes toyed with the notion that a weaker greenback -- which helps U.S. companies sell goods abroad and gives them a pricing advantage over foreign competitors at home -- could be a good thing.

Though nobody feared anything so overt, there was some worry that the tone of the dollar policy would change. Rubin, who worked at

Goldman Sachs

before coming to the Treasury Department, was the trader -- in favor of a strong dollar as a matter of principle. Summers, a former professor at

Harvard

, was the economist. Might his policy be, "Strong dollar if my economic model says the dollar should be strong"?

Those concerns seem valid at first glance given what's happened to the dollar since Summers came on board. Down 4% against the euro, 8.1% against the yen -- the dollar's getting a whupping. But anyone who thinks the dollar's recent weakness has much of anything to do with Summers doesn't get what the strong-dollar policy is all about.

The suggestion that Treasury's decision not to join the

Bank of Japan

earlier this summer in intervening on behalf of the dollar was not, as has been suggested in the Tokyo press, a sign that the U.S. is abandoning strong dollar. Rather, it is business as usual. "What needs to be underscored is the U.S. has consistently had a policy of steering clear of the currency markets unless the market value appears to be extreme and going against fundamental indicators," says James McCormick, currency strategist at

J.P. Morgan

.

Strong dollar is a commitment to policies that make the dollar strong -- not a commitment to intervening on the dollar's behalf whenever it weakens. And in any case, intervening now would be pretty ineffective given what's going on. For the last couple of years, financial instability in emerging markets, meager growth in Europe and a crushing recession in Japan have meant that an outsized chunk of the pool of global capital was going to one place -- the U.S. Now things are beginning to look better around the world and, along with the rebalancing of the global economy, we are seeing a rebalancing of global capital. It's a powerful force in the markets, and not one worth betting against.

"I don't think whether Rubin or anyone else was in control they could offset those flows," says Bill Sullivan, chief money-market economist at

Morgan Stanley Dean Witter

. "It would be like shoveling sand against the tide."

Yet it isn't entirely accurate to say that the dollar's turn of fortune had nothing to do with the changing of the guard at Treasury. For more than a year before he stepped down it was well known in the market that Rubin was tiring of Washington. With the world in a mess, however, he had to put off his departure. Rubin's leaving, then, was a sign that the economic crisis had passed, that the world was healing. The very forces that have taken the dollar lower.

If, as the U.S. economy cools a bit and others warm up, the dollar continues to weaken, the perception will grow that the government's policy has changed. In turn, that may prompt traders to drive the dollar lower than fundamentals suggest it should be. It will be interesting to see if Summers steps in on the greenback's behalf then, and if he'll have the stature to do so effectively.