Deciphering White House's mixed message on dollar

At last week's Group of Eight summit in Évian, France, one major mission of President Bush was financial damage control.

The "damage" arose from a series of statements by Treasury Secretary John Snow in May hinting that a weakening of the dollar on foreign- exchange markets was tolerable. He said the dollar's decline this year "was really fairly modest," suggesting that a further drop would be OK.

The White House soon began to try to squash that idea. In Washington, high-level officials visiting from abroad were assured that the US government was not trying to weaken the dollar. Federal Reserve Chairman Alan Greenspan helped out with the same message for Wolfgang Clement, Germany's economics minister, when he visited last month.

Then the president said in a May 29 interview with Russia's RTR television that "the market, at this point in time, has devalued the dollar, which is contrary to our policy." He confirmed this position with the leaders of the industrial nations at the G-8 summit.

All this caused some confusion in the foreign-exchange markets. One analyst called it a "good cop, bad cop" pattern, with Mr. Snow as the bad cop.

But Harald Malmgren, an economic consultant in Washington with excellent sources, says the Bush statements supporting a strong dollar represent the "real policy." Snow's words were not planned or approved by the White House, where economic policy is crafted by a few top officials, apparently with little influence from the Treasury, the Council of Economic Advisers, or maybe even the National Economic Council.

Bush's stand bolstered the dollar a little in currency markets. But perhaps not for long.

"His words are not enough," says Mr. Malmgren. "The animals are out of the cages. It's hard to get them back in."

Major financial institutions in the US have weakened the dollar by pumping huge sums into eurobond investments. They seek a modestly higher interest rate than available in the US. Also, they have been speculating that the European Central Bank (ECB) would be forced by an economic slowdown in Europe to cut rates.

They were right, potentially reaping nice capital gains. The ECB did slash its key interest rate 50 basis points last Thursday to 2 percent. That brought the eurozone short-term rate closer to the 1.25 percent rate in the US. Both the Fed and the ECB may cut rates further, with Fed policymakers possibly deciding to do so at their next meeting June 24-25.

The dollar's decline has both economic and political consequences. A weaker dollar, after a lag, will boost US exports and make imports more expensive. This will raise the growth rate in the US economy.

But Wall Street has been concerned that a flabby dollar would undermine confidence in the American financial market. Foreign investors might take some of their money out of US stocks and bonds.

If that happened, it could prompt a rise in US interest rates prior to next year's presidential election. That is "clearly alarming" to White House political aides, notes Malmgren.

Higher interest rates would hit the housing market, hurt millions of Americans with credit-card debts or variable mortgage rates, and trouble many indebted businesses.

At the moment, some signs show the US economy picking up momentum, despite a rise in the jobless rate to 6.1 percent in May.

Since March 11, the Dow Jones Industrial Average has risen on average 0.3 percent per day for 58 days. That's a "big run," notes Donald Straszheim, an economic consultant in Santa Monica, Calif. It has added hundreds of billions of dollars to the paper value of investors' portfolios.

Further, the tax cuts just passed by Congress will pump $61 billion into the economy this year and $149 billion next year. Since monetary policy remains easy, that extra money in the pockets of consumers and business should encourage spending and some job creation.

The tax package that emerged from Congress differed considerably from what the president proposed. That probably didn't bother Bush much. He was "not personally as concerned about the specific contents of the tax package as his advisers," Malmgren maintains.

For mainstream Republicans, the cut in the capital-gains tax to 15 percent was the major achievement of the bill. Malmgren says congressional Republican leaders were not unhappy to see the elimination of taxes on dividends disappear. So the insistence of three moderate Republican senators on a theoretical $350 billion cap on the tax bill did them a favor.

Malmgren speculates that if Bush wins reelection in 2004 and Republicans keep control of Congress, the exploding budget deficit will create a budget crisis. Republicans will use this for a fundamental reorientation of the tax system from reliance on income taxes to reliance on some form of national consumption tax. The goal would be to stimulate savings and investment, and thereby spur growth.