Dollar Shows Its Bullish Side

THE US dollar is enjoying a reversal of its bad fortune.

The greenback is no longer the laughing-stock currency that nobody wants to own. Instead, the dollar has risen about 21 percent against the yen and 9 percent against the mark since mid-April.

This week, the United States Federal Reserve coordinated intervention with the central banks in Japan, Germany, and Switzerland to keep pushing the dollar higher by buying the currency on the exchange markets.

"The size of the central-bank purchases was rumored not to be particularly large, but it did have a dramatic effect because activity was so thin," says Dan Seto, an economist with New York-based Nikko Securities Company International.

As the central banks bought US dollars, speculators scrambled aboard. "It's the herd mentality," says Cynthia Latta, a senior economist at DRI McGraw-Hill in Lexington, Mass.

On Thursday morning in London, the dollar continued to rise against European currencies but dropped slightly in Tokyo after 13 consecutive sessions of gain.

Economists cite a lot of different reasons for the greenback's revival.

"The perceived end of the trade war with Japan is important," says Robert Blake, an economist with Citibank in New York. Before the US and Japan settled their differences, many currency traders said they believed the US wanted the dollar to fall. "Now there is a perception the Japanese government is committed to turn the yen and the dollar around," Mr. Blake adds.

The dollar's rally may also be part of a change in perception about debtor countries. After the US committed itself to bail out Mexico, some currency traders lost faith in the US and other large debtor nations. The market required a "risk premium," which Blake speculates may be wound down as dire predictions about Mexico's economy prove to be wrong.

The dollar is also benefiting from perceptions that US assets are cheap. Merrill Lynch & Co. economist Donald Straszheim recently noted that net long-term capital flows to the US from Japan were $44 billion in the second quarter compared with no investment in the first quarter. "Anecdotal information," he says, indicates a further pickup in the third quarter.

The investment in the US is not limited to the Japanese. Paribas Capital Markets, based in London, calculates foreign investors purchased 87.6 percent of the $80 billion in net new US Treasury securities offered for sale in the first half of this year.

Foreign investors may be influenced by Congress's efforts to reduce the deficit. "If Congress does come through with deficit cutting and the economy pulls out of the mid-year slump, the dollar stands to improve even more," Mr. Seto says.

Although the Federal Reserve Board did not react when the dollar was weak, Mr. Straszheim says the greenback's improvement "makes it easier for the Fed to ease" interest rates. Right now, US short-term interest rates are about 1.5 percentage points higher than in Germany, where the inflation levels are about the same. "A Fed easing would help keep the dollar from overshooting on the upside," he adds.

If the dollar maintains its gains, there are several economic ramifications. Over the short term, foreign tourists now in the US will find their vacations slightly more expensive while US tourists abroad will not complain as much about high prices.

Foreign exporters, with profit margins under pressure, will get some relief. A stronger dollar makes imports cheaper. "If the dollar had remained low we would have seen more of an adjustment in the prices of imports," Ms. Latta says.

Overseas investors may also view the US as a more attractive place to invest if the dollar remains stronger. "This would be favorable for the bond market," explains Robert Dederick, an economic consultant for Northern Trust Company in Chicago.

Any changes in the value of the dollar often take a long time to be reflected in the real economy - some economists estimate as much as a two-year lag to affect trade flows. Citibank's Blake concludes that the stronger dollar may have an effect in a year "but probably not a huge effect."