Deft rescue of dollar still poses risks for central banks, nations

FINANCIAL circles called the central bankers' action to defend the United States dollar a ``bear trap.'' The governors of the Federal Reserve System, the Bank of Japan, and the West German Bundesbank waited for weeks as the dollar slid on the foreign-exchange markets. The dollar ended 1987 down about 25 percent compared with the Japanese yen and about 20 percent against the German mark. The dollar had fallen for 12 trading days in a row against the yen. One greenback could buy only about 121 yen. Pessimism among traders was rife.

Then, clang! The central bankers sprang their trap.

Last Monday these three banks, with some help from central banks in other industrial nations, intervened in the exchange markets to support the dollar. They did it with class. It was reported that the Bank of Japan bought between $1 billion and $2 billion of yen. The Fed sprinkled $10 million and $25 million orders for dollars around the commercial banks, letting it be well known that it was out to protect the dollar.

The central bankers repeated their dollar purchases Tuesday.

Bears - pessimists on the dollar - were caught in the trap if they had sold the currency short. Many undoubtedly lost money as the dollar rose about 2 percent on the exchange markets.

On Wednesday the central bankers retired from the hunt. But the dollar rose by itself on the markets both Wednesday and Thursday.

This whole exercise is a risky move, both for the central banks and the nations.

The central banks could lose a lot of money if they stepped in too early. Last year, it has been estimated, foreign governments added at least $130 billion to their reserves as they supported the dollar. The Bundesbank lost about 6 billion marks (about $3.6 billion) on the dollars it had acquired. That has put a big hole in the Bonn government's revenue picture. The Bank of Japan undoubtedly has also lost money on its dollar purchases. British reserves doubled last year, to $44.3 billion, as a result of intervention.

The Fed has been less active in supporting the dollar. But if it has been borrowing yen and marks to buy dollars, as seems likely, it too could lose if the dollar continues its downward slide.

Much depends on the trade figures for November, to be released Friday. The Fed may have advance knowledge that these will be favorable. Many outside analysts are expecting an improvement over the October record monthly deficit of $17.6 billion.

For example, Wall Street's William N. Griggs and Leonard J. Santow suggest the trade deficit will be about $15 billion in November and $13 billion or $14 billion in December. Michael H. Cosgrove of the Econoclast, an advisory service, figures the merchandise trade deficit will decline to $145 billion this year, from about $157 billion in 1987.

``We might have one more bad month,'' says Mr. Cosgrove. ``But we should see significant improvement over the next six months.''

The dollar has already fallen to a level close to that considered appropriate by 33 economists who cooperated with the Institute for International Economics in Washington to propose last month a strategy for dealing with the global economic crisis.

But the potential losses to society as a whole dwarf those facing the central banks, notes Allan H. Meltzer, an economics professor at Carnegie-Mellon University. It bothers him that the Group of Seven industrial nations has agreed to peg the dollar within a specific range against the mark and the yen.

Should that range be too high, he warns, the Fed would have to maintain high interest rates and slow money growth to support the dollar in the foreign-exchange markets. That could eventually result in a recession in the US. Abroad, more intervention in the currency markets to support the dollar would expand the money supply further in Germany and Japan, risking greater inflation.

``I don't want them to peg the dollar,'' Professor Meltzer says. ``It is a foolish policy and very shortsighted.''

The Fed, of course, is aware of these dangers. But it worries too about new inflationary pressures arising from a plunging dollar and the possible destabilization of financial markets.

Economists have for decades debated the merits of government intervention in currency markets. The pendulum of opinion has swung from favoring fixed rates before 1971 to free-floating rates for a decade and a half. Now there seems to be a compromise - pegging rates within a range when central bankers can manage it. It is a gamble.