10/26/98 COMMENTARY: A NOT-SO-BRAWNY GREENBACK TO THE RESCUE!

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COMMENTARY: A NOT-SO-BRAWNY GREENBACK TO THE RESCUE!

You have to wonder if Federal Reserve Board Chairman Alan Greenspan and Treasury Secretary Robert E. Rubin are silently applauding the dollar's recent weakness. Since late August, the trade-weighted U.S. currency has dropped 10%. But a less muscular greenback could be the first step toward world financial market stability.
Clearly, no policymaker wants a repeat of the dollar's chaotic Oct. 8 plunge vs. the Japanese yen: As hedge funds had to sell dollars to cover bad bets on a falling yen, the dollar sank 9% in that session. And a stronger yen hurts Japan's export prospects, even as the country is gripped by recession.
EXPORT BOOST. However, an orderly decline in the dollar will accomplish several things crucial to getting the global economy back on its feet. First, a weaker dollar will help the U.S. economy by lifting pricing power and boosting exports in the hard-hit manufacturing sector. Also, it will relieve pressure on economies with dollar-pegged exchange rates, such as Brazil and Hong Kong. Plus, it will lift the export competitiveness of emerging Asian nations, particularly South Korea, by providing a currency advantage over Japan. Finally, it will help to redirect capital to nondollar investments, a crucial step in restarting battered economies.
A weaker dollar is justified by fundamentals. With the Fed cutting interest rates, and with prospects for U.S. growth diminishing, dollar-based investments are becoming relatively less attractive. Also, the U.S. current-account deficit, comprising the gaps in foreign trade and net investment income, hit 2.7% of gross domestic product in the second quarter, a full percentage point rise in the past year. It is now probably greater than 3% and approaching levels that preceded the dollar's decline in 1985. The markets rarely allow any free-floating currency to remain strong when it faces foreign obligations that large.
Moreover, Japan may be moving to fix its banking system--Japan's and the world's No.1 financial problem. If so, Japan could begin its return to health, boosting the allure of yen investments. Also, a stronger yen increases the import purchasing power of Japanese consumers.
For the U.S., a weaker dollar acts like an easing of monetary policy. The 10% drop, by itself, is equivalent to a 1/2- to 3/4-point cut in rates by the Fed. And the stimulus will provide recession insurance by going mainly to the U.S. manufacturing sector, where the Asian crisis has left its deepest scars, including weak pricing and profits, stagnant output, and layoffs.
Internationally, a weaker greenback will improve the prospects of ailing foreign economies by lessening the likelihood of speculative attacks on their currencies. Policymakers have made Brazil their first line of defense against further global turmoil, and a weaker dollar would take pressure off the Brazilian real. China would also be less likely to devalue.
A key risk to this scenario would be Japan's failure to carry through with its latest recovery initiatives, especially the bank bailout. Currency markets would turn on the yen, pushing the dollar back up. Another risk is U.S. inflation. After all, the dollar's 25% surge since 1995--and the resulting drop in import prices--has been a key factor curbing overall inflation in a very strong economy.
But on balance, a modest devaluation of the dollar is a welcome development. Remember, the Asian crisis was first and foremost a currency crisis. It was the superstrong U.S. dollar that helped to expose Asia's underlying economic problems, leading to the collapse of its currencies. Some moderation in the dollar must be a key part of the solution.
By James C. Cooper

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