Worried About the Dollar

By Adam Zagorin/Washington

Getting nervous? In the past two weeks, the Dow Jones industrial average has fallen 529 points, a drop of nearly 10% since its August peak, punctuating a dismal third quarter. Investors are hoping--praying might be a better word--that Fed Chairman Alan Greenspan will decide against the third interest-rate hike of 1999 when the central bank's Open Market Committee meets this week.

Much of the trouble stems from a single concern: the weakening U.S. dollar. The greenback had been the strong, silent type for the past six years, making European vacations and Japanese electronics cheaper, while at the same time attracting foreign capital to the U.S. stock-and-bond markets by the trillions. Although the dollar's decline amounts to only 3% against major currencies like the euro, it is off nearly 15% against the Japanese yen since March.

Why should we care? Because if the buck falls out of bed, there's trouble ahead. Consumers will have to pay more for imports, which can light a fire under inflation. Imports make up more than 17% of all consumer goods bought in the U.S., or $407 billion, up from only 5.4%, or $19.2 billion, in 1970.

The economy looks pretty healthy until you think about the $1 billion Americans borrow from abroad--each day--to support their big appetite for foreign stuff. Result: this year's current-account deficit, which measures the gap in both trade and investment flows, is headed for $300 billion, up from $155 billion in 1997. That is worrisome to Joel Prakken, chairman of Macroeconomic Advisers, a St. Louis, Mo., forecasting firm, who says, "U.S. indebtedness is growing more than three times faster than the economy, and that can't be sustained."

That has the market spooked too. Foreigners have been taking the dollars they get as payment for goods and services and investing them in U.S. stocks and bonds. If the dollar continues to droop, they may be tempted to move their cash to currencies on the upswing, like the euro and, especially, the yen. That would drive the U.S. market lower. The more apocalyptic bears fear something worse. Because foreigners hold almost 40% of U.S. Treasury securities, any pullout would risk a spike in interest rates that would ultimately slaughter the bull market.

The dollar's plight is the first major challenge for Treasury Secretary Larry Summers, 44, the economist who succeeded Robert ("Just Right") Rubin three months ago. Summers' mantra--"A strong dollar is in the national interest of the United States"--was the same one repeated for six years by Rubin, a period during which the Dow rose a mountainous 7,000 points. In contrast, the as yet brief Summers era has seen the index drop some 900 points. But Summers says his focus is on "the fundamentals," such as creating a budget surplus, which he argues is best for both the economy and the markets.

Since the U.S. economy remains basically strong, Treasury officials say the rising yen is Tokyo's issue. And they've convinced Japan's major trading partners of that, not to mention the government of Prime Minister Keizo Obuchi. Everyone, that is, except Masaru Hayami, chief of Japan's central bank, who late last month got into a public spat with Tokyo's powerful Ministry of Finance because the Bank of Japan refuses to lower interest rates or print money to bring the yen back to earth.

For Japan, a weak dollar and a powerful yen are a decidedly mixed blessing. Yen strength amounts to a vote of confidence in the Japanese economy, which, after a decade-long slump, is at last beginning to show signs of life. The renewed activity has sucked in U.S. and other foreign money for 33 of the past 35 weeks, driving up the Nikkei stock market average some 25% so far this year. The problem is that Japanese corporate profits are also heavily dependent on exports, which can rapidly become too expensive for foreign consumers as the yen appreciates. Indeed, big exporters like Mitsubishi and Bridgestone have begun to complain publicly that Japan's currency is too strong. Sony recently blamed a profit slump on the yen as well.

For the U.S., nearing the longest expansion in history, some cooling of growth is inevitable. An accompanying step down by the dollar may even be beneficial, just as long as it doesn't lose its footing entirely.

--With reporting by Bernard Baumohl/New York

With reporting by Bernard Baumohl/New York