Teaming Up to Rescue the Dollar

By Stephen Koepp

For Currency Trader Randall Holland, the first working day of 1988 started last Monday with an urgent 2 a.m. phone call from Tokyo. Jolted out of bed, Holland, who works for Wall Street's Donaldson, Lufkin & Jenrette, listened groggily as an excited colleague in Japan reported that the U.S. dollar was moving in a sharp and startling new direction: upward. Skeptical of the currency's mysterious strength, Holland gave orders to sell part of the firm's dollar holdings, then went back to sleep. At 4 a.m. the phone jangled again. This time it was a London colleague calling to report that the dollar's rally was gaining momentum. Holland, abandoning any hope of getting back to sleep, put on a robe and padded into his den, where his computer terminal graphically displayed the dollar's takeoff. "Holy smoke, something is happening!" the trader exclaimed before jumping into his clothes and hailing a cab for Wall Street. "They apparently mean business."

Holland was right. "They" -- the central bankers of the world's industrial countries -- were launching a major surprise mission to rescue the dollar from its perilous slide. The Federal Reserve and other central bankers intervened by unleashing a flood of orders to trade Japanese yen, West German marks and other denominations for the dollar. The strategy worked stunningly, sending traders scrambling to move in the same direction. Said Holland: "You don't make money by challenging the Fed. You could get squished trying to do that."

The dollar, after opening in Tokyo Monday at a post-World War II low of 120.45 yen, rocketed to 129.45 by Thursday in New York. Against the West German currency, the greenback jumped from a record low of 1.56 marks on Monday to a week's high of 1.65. But no one could say whether the dollar's comeback could endure. The fragile currency backslid somewhat against the yen and mark on Friday in reaction to estimates that the U.S. budget deficit would balloon once again in fiscal 1989.

The concerted central-bank intervention marked the most aggressive effort so far to moderate the decline in the dollar that was deliberately set in motion in September 1985 by the major industrial democracies. Since then, the dollar's 50% drop against the yen and the mark has made American goods cheaper -- and thus more competitive -- in world markets. But by last February the industrial countries proclaimed that the dollar's fall had reached a point of diminishing returns. The governments of Japan and West Germany, among others, began intervening in the market to cushion the sliding American currency. The U.S., however, was reluctant to intervene wholeheartedly because it wanted to reduce the stubbornly large trade deficit.

The dollar continued to slip even though foreign governments spent almost + $100 billion during 1987 to prop up the currency. By late December the dollar went into a nose dive. Unbeknown to most traders, though, the central bankers were quietly baiting a so-called bear trap, in which they aimed to punish speculators who had been reaping profits by consistently betting on the dollar's downfall. They secretly agreed to launch a dollar-buying binge when the currency hit a floor price, possibly at 120 yen. At first only the Bank of Japan came to the rescue. Then all at once last Monday, moneymen from central banks around the world -- including the Federal Reserve -- got on the phones to place buy orders.

The amount the governments spent on their intervention, an estimated $6 billion last week, is dwarfed by the total amount of dollar trading, some $150 billion, that swirls through the currency markets each day. But the central banks can move the market because of their resolute purpose; they hold on to their purchases, even at a loss, while speculators constantly churn their holdings. Moreover, last week's intervention was far more aggressive and flamboyant than usual. The Fed, which generally makes orders in $10 million batches, was trading marks for dollars in king-size packages of $25 million. Normally the Fed would carry out such transactions stealthily. But last week a Fed official reportedly went so far as to encourage a trader at a major bank to talk about the Government's big move in a TV interview.

The central banks handily accomplished their short-term goal. "They have sent a message: It is no longer a sure thing to bet against the dollar," says Robert Hormats, vice chairman of the Goldman, Sachs International investment firm. Intervention, however, can be used only for fine tuning a currency's general direction. Too much intervening can disrupt a country's domestic economy. West Germany in particular is getting weary of issuing so much of its own currency to trade for dollars, a process that can lead to inflation.

The only way to stabilize the drooping dollar over the long term is through fundamental economic changes, notably by reducing the federal budget deficit. Without such measures, the Fed may eventually be forced to support the dollar by putting upward pressure on U.S. interest rates. But that step presents a painful election-year dilemma for Fed Chairman Alan Greenspan, particularly in the wake of October's stock crash, since any rise in interest rates might send the U.S. and world economies into a recession.

& The next turning point may come this Friday, when the Government releases the U.S. trade-deficit figure for November. If the deficit shrinks from October's $17.6 billion to $15 billion or less, the financial markets are likely to take this as evidence that the dollar has fallen enough to begin remedying the problem. But if the gap remains wide, the beleaguered dollar may need an even more costly rescue mission.

With reporting by Jerome Cramer/Washington and Thomas McCarroll/New York