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World: Dollar Shows Sudden Strength

Prague, 11 August 1997 (RFE/RL) -- One of the most spectacular stories in world economics these days is the stunning sharp rise of the U.S. dollar against most major currencies. Against the Deutsche mark, for example, it is at its highest level since before the Berlin Wall fell.

A few figures illustrate the magnitude of the dollar's rise. Just two years ago, the dollar was so weak that the central banks of the world's most advanced industrialized countries (G-7) intervened to push it back up.

At that time the dollar bought only 1.35 Deutsche marks. This week one dollar buys about 1.87 DM and is expected to rise to 1.90 DM or even more. Just this year, the dollar is up more than 20 percent against the Deutsche mark -- 9.5 percent just since June.

The dollar's rise has ramifications around the world, because it is an international currency, not just used by U.S. residents. More than half the world's trade is conducted in dollars. Oil, one of the world's most important commodities, is bought and sold for dollars. In many countries where faith in the local currency is low, people prefer to hold their savings in dollars, and most important transactions take place in dollars rather than the local currency. Russia is only one example.

What is behind the amazing rise of the dollar? On a technical level, it's all related to comparative interest rates in major countries. Short-term interest rates in the United States now stand at 5 percent. This is 2 percentage points higher than in Germany and 4.5 points above the level in Japan.

This means it is more profitable for investors to put their money into the United States, than to keep it in Germany or Japan.

"The U.S. is an attractive place to have your money," said David Ogg, manager of foreign exchange at Dresdner Bank

To invest in the United States, foreigners must buy dollars and sell their own currencies. This increased demand for dollars has the effect of pushing the dollar up against the currencies that are sold, in this case Deutsche marks or Japanese yen.

That's the technical factor. But on a broader scale, the relative values of currencies show how the world's markets evaluate the economic performance of various countries. And the U.S. economy is performing so well that normally staid economists are using words like "miracle" and "nirvana" to describe it. At the same time, European countries are finding it hard to climb out of recession and are hurting their own currencies by their determination to forge a single European currency (the euro) by 1999.

The U.S. economy is performing so well that economists are beginning to wonder whether the laws of economics have been rewritten. The Phillips curve, an article of faith in economics for some decades, teaches that low unemployment means high inflation and vice versa. Its chief implication is that it's impossible to have low unemployment and low inflation at the same time.

But the U.S. economy is turning that on its head. Inflation in the United States is at its lowest level in 34 years, while unemployment is at its lowest in a quarter of a century.

President Bill Clinton and the U.S. Congress have managed to cut government budget deficits for four years in a row, and just worked out a landmark agreement that will balance the federal government budget for the first time in a generation and cut taxes by the largest amount since 1981.

This all adds up to make everyone -- from U.S. citizens with $1,000 to invest, to people who manage millions of dollars in mutual fund investments -- believe that the U.S. is an unbeatable place to make money these days.

As a result, the stock market has soared, hitting one record high after another, day after day. This draws in investment money from around the world, again pushing up the dollar as foreigners buy dollars to invest in the U.S. stock market.

All this is in stark contrast to the situation in Europe. France and Germany, the lead economies on the continent, now have by far the worst growth outlooks of all the industrialized countries. Both economies have failed to take the tough, painful steps of restructuring their economies and making them more efficient, as the U.S. has accomplished so well.

Both Germany and France are preoccupied with pushing ahead with the euro in 1999. But ironically it looks like neither country will meet the rigid economic and fiscal requirements. These will likely be disregarded, at the same time that weaker currencies like the Italian lira are brought in.

The result will be a weak euro replacing the strong Deutsche mark as Europe's benchmark currency. Even two years before its launch, the euro is being written off as a weak currency. This increases the pressure to hold the Deutsche mark down against the dollar.

All these factors make sense. What is not clear is why the dollar has moved up so quickly in the last month or so.

"Many prophesied that it would continue . . . rising, but none foresaw the sheer speed of it," wrote Winfried Muenster recently in the Sueddeutsche Zeitung.

"It's not the level, but the movement, the rapid depreciation of the mark that worries us," added Otmar Issing, chief economist of Germany's central bank, the Bundesbank.

There is no reason to think the dollar will fall any time soon. For one thing -- and European governments don't like to talk about it -- low currencies boost exports from their own countries. This is because someone with dollars finds a German car, a Japanese television set or French champagne dramatically cheaper than a year ago -- so sales of all these exports go up. As one economist (Francois Chevallier of Natexis economic research firm in Paris) put it, the only hope for economic growth in many European countries is the stronger dollar that stimulates exports.

Furthermore, German authorities have no maneuvering room for boosting the Deutsche mark. In normal circumstances, the German authorities would stem the drop in the DM by raising interest rates. But that is nearly impossible in today's fragile German economy, which is showing little signs of recovery from a five-year slump.

A rise in interest rates would lead to higher borrowing costs for German companies and individuals, which would depress the economy and make it difficult for companies to take on new workers and thereby cut the unemployment rate. At the same time, a stronger mark would hurt exports, which are the chief engine behind any signs of improvement in the German economy.

In addition, the U.S. government has said clearly it is satisfied with the strong dollar, and will not take any steps to push it down or halt its rise. And in purely economic terms there are no signs of inflation in the U.S. economy that would dampen the dollar's strength.

So the message is clear.

"It seems to be everyone's idea that the dollar's rise is going to continue," said John Hazelton, chief currency trader at Manufacturers & Traders Trust Co. in New York.

(This is the first of a two-part series on the effects of the dollar's rise. See The East: Strong Dollar Could Be Blessing)