The dollar falls, and Treasury stands aside

In a significant shift, the United States is backing away from verbal support of the dollar - a move that will affect everything from the European economy to home mortgage rates in Kansas.

For the past eight years, Washington has considered it important that the US dollar remain strong compared with other currencies. Now it is apparently less willing to define the greenback in terms of yen, euros, or pounds sterling and instead is using less tangible measurements.

The result: The dollar, which has already fallen 8 percent in two months, is likely to drop even more. The move may help the US economy by boosting exports, allowing American companies to book more orders for everything from aircraft to bulldozers.

Yet it will likely hurt the already fragile European economy. It will make it more difficult for overseas firms to sell goods here and further curtail US tourism abroad.

At the same time, the move could rattle the US financial system. With a trade deficit of about $42 billion per month, the US has to attract foreign capital to finance the yawing gap. Much of the foreign money that comes in gets invested in US stocks and bonds.

"This is a dangerous policy because the US is addicted to capital," says Robert Brusca, an economist with Native American Securities. "And people don't like to invest their money here and find out they have an instant loss."

The subtle change came out of a meeting of the Group of Eight finance ministers over the weekend in Deauville, France, where Treasury Secretary John Snow signaled the US would no longer defend verbally the greenback as it falls in value. Instead, he said the dollar should be viewed in terms of the more generic "public confidence" and resistance to counterfeiting.

The move is apparently intended to help shore up the US economy. But as the stock market fell early Monday and criticism mounted at home and abroad, the White House moved quickly to try to calm fears. Spokesman Ari Fleischer said there has been "no change" in the US position in favor of a strong dollar. But he declined to define a strong dollar.

Since January of last year, the dollar has been anything but strong. On a trade-weighted basis, it's down about 22 percent - a significant decline over a short term.

This is a reversal from the 1990s when the dollar rose steadily. Treasury Secretary Robert Rubin voiced support for the rising dollar. The strong greenback made it cheaper for Americans to travel abroad and to import all kinds of goods. Foreigners flooded the rising stock market with money, pushing the dollar still higher.

Yet now the US economy is struggling. Exporters are trying to find new markets. Interest rates are very low, making yields lower for foreign investors. And the declining dollar means that it now costs more to import goods and services.

"What a weaker dollar means is we must give up more goods and services to get the same from the rest of the world. It makes us less well-off," says Paul Kasriel an economist at the Northern Trust Company in Chicago. "Our standard of living will go down."

But the news of an apparent shift in American dollar policy was welcomed by John Williamson, an economist at the Institute for International Economics in Washington. A "more realistic value for the dollar," says, would be good for the United States economy, boosting exports and discouraging imports.

Moreover, any comparative rise in the euro should encourage the European Central Bank to reduce interest rates in the 12-nation euro area, Mr. Williamson says. The stronger euro reduces any inflation pressures in Europe. And an interest rate cut is needed to bolster European economies that may be slipping into recession.

The powerful German economy has lately shown signs of considerable weakness. Williamson hopes that a weaker dollar may also prompt Japan to carry out major banking reforms and ease monetary policy further.

A lot will depend on how fast the dollar dives. "A collapse of the dollar would be a disaster," says Clyde Prestowitz, head of the Economic Strategy Institute in Washington. Much better would be a "slow and gradual slide" into a "more realistic equilibrium" with currencies of other countries. If history is any guide, the dollar will "overshoot in its fall," says Williamson. "I don't have any great faith in our ability to control it."

Indeed, Mr. Kasriel notes that Treasury secretaries, such as Mr. Snow or Mr. Rubin, have a limited impact on the greenback. "All the secretary can do is jawbone," he says.

Instead, the dollar is more apt to move in relation to changes in interest rates and in the economy. For example, Federal Reserve Chairman Alan Greenspan's warning about deflation helped to drive the dollar lower as foreign investors anticipated another interest rate cut. "The dollar has had a big decline since the economic data has been weaker," says Kasriel.

Mr. Prestowitz suspects that one element in the dollar's decline has been the jump in the budget deficit in the US. Foreign investors see this as pointing to an even greater need for the US to import capital. Already, he says, the US "has been living beyond its means."