The other source of market suspicion on U.S. foreign exchange policy rests with the Bush Administration itself. While Treasury Secretary Paul O'Neill has reiterated that a strong dollar preference remains in place, he has not been too successful in communicating that commitment.
In February, O'Neill pointed out that the U.S. did not really have a explicit strong dollar policy -- the greenback's strength only reflected the solid fundamentals of strong growth and a favorable investment climate. With U.S. corporate profits and manufacturing in recession, though, the market rightly or wrongly started to tie a weak economy to a lower dollar orientation by the Bush White House.
MIXED MESSAGE. O'Neill has since repeated the Administration's commitment to a strong dollar by insisting that he would rent out Yankee Stadium with a brass band if that policy ever changed. And yet President Bush's first foray on the subject before the G8 summit in July only seemed to add to policy confusion, as he emphasized that markets determine foreign exchange rates in reality. Hence, the dollar weakened in line with dismal economic data for July and a downbeat Beige Book report from the Federal Reserve.
In early July, the dollar's trade-weighted value hit a 15-year high but has since corrected 6%, with the euro's value against the greenback hitting $0.91 for the first time since March. But a weaker dollar so far in August has been met with silence from Bush's international macroeconomic policy team. This feeds into market suspicion that a gradual reversal in dollar strength may be tolerated until U.S. economic growth looks to be on firmer ground.
That's not to say Secretary O'Neill or Bush's chief economic adviser Lawrence Lindsey will stop voicing the dollar mantra. What seems certain is that the U.S. government is unlikely to stand in the way of a market-led decline. Foreign exchange market intervention -- central banks buying or selling currencies to achieve desired targets -- is a no-no to Lindsey. Even in a disorderly market, it's unclear if he would recommend dollar support action.
TOO STRONG? The issue now at hand is whether the market sees diminishing returns from a strong dollar. On the inflation side, the benefits have been clear. U.S. import prices are now down 4%, year-over-year, while the core intermediate producer price index posted its biggest monthly drop in its 28-year history in July.
But the dark side of falling global inflation is weaker corporate pricing power and the ongoing hit to profit margins. Further distress on that front may bring another leg down in capital spending by corporations -- and more job cuts. Given this policy trade-off, a stronger dollar may be seen as too much of a good thing. Ethridge is director of global bond research for Standard & Poor's Global Markets