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The Buck Stops Where?


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THE BUCK STOPS WHERE?

Gravity has gotten the better of the dollar. Struggling to keep its value since the Federal Reserve cut interest rates in early July, the greenback finally gave way Aug. 21, when it began a two-day plunge that drove its value down 3% against the German mark--a postwar low. The Federal Reserve and other central banks hit the foreign exchange market hard, buying up billions worth of dollars. But the bankers just couldn't hold the line.

It is a currency collapse that is likely to have dramatic repercussions--for European unity, the global economy, the U.S. Presidential race, and many international businesses. And the dollar, drifting downward since spring, has far from bottomed out. "It's going down like mad," complains Horst Sandfort, president of chipmaker LSI Logic Corp.'s European arm.

DOOMED FACTORY. Among the world's big companies, there are a lot of losers, particularly European outfits with extensive ties to the U.S. Grand Metropolitan PLC, the London-based food and beverage behemoth that owns such well-known American names as Pillsbury Inc. and Burger King Corp., was already facing profit pressure because of the slow U.S. economy. The dollar's slide made it much worse, since Grand Met must convert its U.S. profits back into the British pound. On Aug. 25, the company warned that the dollar's loss will cost it about $40 million in profits in the second half, wiping out its first-half gains. Grand Met shares fell 8% in London on the news.

Some U.S. manufacturers are suffering, too. LSI in Milpitas, Calif., is one. The dollar downdraft spelled doom for its $70 million plant in Braunschweig, Germany. On Aug. 24, as traders were dumping dollars, LSI said it would close the factory. "Ninety-five percent of our output is exported to the U.S. and Southeast Asia," says Sandfort.

For some U.S. exporters, though, the dollar drop has a bright side. General Motors Corp.'s European auto-components unit buys some $300 million in U.S.-made parts, then assembles them into power-steering systems and other products that it sells in Europe. The dollar's decline means bargain shopping for the GM unit, though the benefit is tempered by Europe's weak economic condition. Then, there's Digital Equipment Corp., which draws 49% of its revenues from Europe. The Maynard (Mass.) computer maker says the dollar's drop could benefit earnings later this year--though the continent's economy now is too weak for an immediate upturn.

Behind the dollar's free-fall is the fact that the world's No. 1 and No. 3 economies are pursuing diametrically opposed monetary policies. Germany has jacked up interest rates to combat the inflation brought on by the costs of absorbing eastern Germany. Since most European interest rates are linked, Bonn's tight-money program has hindered economic recovery for Germany's less-prosperous neighbors. Among the major economic powers, only Japan, suffering its own woes, is minimally affected by this fray.

Meanwhile, in the U.S., the Federal Reserve has gone in a radically different direction from the Bundesbank--pulling down rates to rejuvenate a limping American economy. The result? Traders are bailing out of dollars: The currency, trading around 1.40 marks, has lost 9% of its value since the July 2 rate cut. And that has landed a gut blow to U.S. securities exchanges (charts).

Nobody expects a respite anytime soon. The Fed can't stop the mark, and raising interest rates to boost the dollar is out of the question (page 28). The Bundesbank won't budge from its high-rate course, despite immense pressure from economic ministers throughout Europe, and its own projections that Germany will grow a blah 2% at best this year. Observes Peter Pietsch, an economist at Commerzbank: "If the Bundesbank cuts rates now, it will mean they bowed to international pressure for the first time in history."

POUNDED POUND. In Europe, the mighty mark jeopardizes the future of the Maastricht Treaty. The pact, cementing the Continent economically and mandating a single currency by 1999, was rejected by Danish voters earlier this year. Now, French voters, facing unemployment of about 10%, are wavering on the treaty just weeks before their Sept. 20 ratification vote. Indeed, the French seemed to lose confidence in the treaty with each uptick of the mark: Recent polls show that voters are evenly split on Maastricht.

That's ironic, says Eric Taze-Bernard, an economist at Banque Indosuez in Paris, because Maastricht was partly designed to replace the Bundesbank with a pan-European central bank. "If Europe had monetary union today, there is no doubt that interest rates would be lower," he says.

The result of Germany's tight-money policy is most pernicious in Britain, the economically hardest-hit major European power. The British economy dropped 2.4 percentage points last year and could lose 0.5 points more this year. In July, imports outstripped exports--even with the economy in tatters. The British would love to cut their excruciating 10% interest rates to ease their severe recession but can't because that would plunge the pound into the netherworld. Indeed, with the pound under pressure, admits a senior government source, a rate increase still might be necessary.

In the U.S., a weak currency is an indictment of persistently high government deficits--and signals to the world that the U.S.'s economy is too anemic to turn around soon. The dollar disaster has shown that the world's currency traders, at least, don't believe that President Bush--or Arkansas Governor Bill Clinton, for that matter--can reduce the federal deficit, restore economic growth, end the real estate depression, and revive the U.S. stock market.

The dollar's daze could become an issue in the Presidential election, particularly if U.S. stock and bond markets continue to slump. Bush, as the incumbent, is the one who stands to sufferany backlash from the American public.

Will this stuff hit home beyond the U.S. investment community? Charles Black, a senior adviser to the Bush-Quayle reelection committee, says questions about the dollar are "pretty complicated for the average voter. That will be outshouted by the pure domestic concerns." But Clinton's entourage is betting that the dollar's woes will be another piece of evidence that even the economically unsophisticated can read. "The people who voted with their dollars voted that the Bush economic plan is a fraud," declares Gene Sperling, Clinton's issues director for economic policy. If the President--as well as Wall Street and a lot of corporations--gets lucky, the game of bloodletting the buck will take a breather.David Greising in Chicago, with John Templeman in Bonn, Richard A. Melcher in London, Stewart Toy in Paris, and bureau reports


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