Still-Higher Interest Rates Could Stem Dollar's Slide

Economists grapple with causes for the shrinking value of the dollar after 16 central banks were called to its rescue last week

A NATION'S currency often reflects investors' political and economic hopes and fears.

So why has the United States dollar - during a period of economic growth and political stability - been so weak that last week it had to be supported by 16 central banks? Economists offer all kinds of suggestions:

* Politics. ``The problem is made in Washington,'' says Donald Straszheim, chief economist for Merrill Lynch & Co. ``There is a great deal of questions about Washington's handling of foreign affairs among market participants.''

* Inflation fears. ``The people Clinton has appointed to the Federal Reserve Board appear to be not as concerned about inflation as they are in maintaining economic growth,'' explains Sandy Batten, a Citibank economist. ``It gives the whole world hesitancy in holding dollar assets.''

* Money. ``I think what has happened is that since the Fed started to tighten, people have concluded that the bull market in US stocks and bonds is over and they are now looking around for the best place to park their money,'' says Paul Kasriel, an economist at Northern Trust Company in Chicago.

Whatever the reason for the shrinking value of the US dollar, last week it attracted the attention of the world's central banks, which put enough money into the greenback to stabilize the currency and teach the speculators that there are two sides to every market. On Friday, the dollar in New York closed at 1.6630 deutsche marks and 102.53 yen.

The US currency was flat on Friday when the government reported that April employment grew faster than the markets anticipated. This followed a large employment increase in March. As a result of the increase in employment (the unemployment rate shrank to 6.4 percent), the stock and bond markets fell on Friday. The Dow Jones industrial average closed at 3669.50, down 26.47 from Thursday.

The markets fell in anticipation that the Federal Reserve Board would hike interest rates in the next week. Mr. Straszheim says he expects the Fed will raise the federal funds rate - the rate that banks lend money overnight to member banks - by one-half of a percent.

It is possible that still-higher US interest rates will help to stem the dollar's slide. Mr. Kasriel reasons that global investors cashing out of the US stock and bond markets are getting better short-term interest rates in foreign markets. If the US inflation rate (as measured by the consumer price index) is 2.5 percent, and the Federal Funds rate is 3.75 percent, then the investors only get a real return of 1.25 percent. However, in Germany the overnight funds are 5 percent and German inflation is 3.25 percent, giving a real return of 2.25 percent. ``Why not park the money in Germany till you can figure out what to do with it?'' Kasriel asks.

This may explain why the deutsche mark has been so strong. It does not explain the strength of the yen, however. Bob Brusca, chief economist at Nikko Securities International Limited Inc., says the yen has been strong because Japanese investors now realize that investments in US securities are money-losers. Nikko Securities examined a 10-year period from 1982 to 1992 and found that during that time, a Japanese investor would have been better off putting money in a 10-year yen note rather than a 10-year Treasury bond. Although US interest rates have been higher, Mr. Brusca notes, ``the change in the currency wiped out the gains.''

Some economists say politics has worsened the yen-dollar relationship. ``There is a perception [that] Clinton has used it as an element in negotiating with the Japanese,'' Mr. Batten says. ``The administration has done nothing to dispel the markets of this notion.''

Straszheim of Merrill Lynch says he agrees that the problem originates in Washington. ``We've had a policy of benign neglect with respect to the dollar,'' he explains. Although the administration has not intentionally devalued the currency, ``they have left the impression [that] a falling dollar was a positive in terms of putting more pressure on the Japanese,'' he adds.

Last week, the US Treasury decided the dollar had fallen far enough. The Fed intervened to stop the slide. But as Straszheim notes, there are limits to how much impact a central bank can have.

``They can restore stability to unstable markets ... but they cannot make a currency go up when the markets want it to go down,'' he says.

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