Alan Reynolds

Michael Blumenthal was Treasury Secretary from 1977 to 1979 under President Carter. He soon began preaching that a weak dollar was good for America. Exchange traders obliged by dumping the dollar by nearly 14 percent against major currencies. But the dollar's drop against our broad mix of currencies was less dramatic: The dollar peaked at 34.9 in September 1977, sliding to 31.7 13 months later and then edging up. Efforts to unload dollars before they shrunk did indeed "stimulate demand" -- inflation jumped to 9 percent from December 1997 to December 1998, and to 13.3 percent over the following 12 months. But imports rose and their prices rose, too, and the trade deficit did not "improve" until the recession of early 1980.

The Fed kept interest rates below the rising inflation rate, so it paid to borrow cheap and speculate in tangible assets like gold. That game ended in 1981, as Ronald Reagan let Fed Chairman Paul Volcker push the fed funds rate to 16 percent to 19 percent. The high real return on cash attracted hot money, so the broad dollar soared -- from 35.1 in January1981 to 47.3 by November 1982. As the U.S. economy and stocks exploded with the tax cuts of 1983-'84, so did the greenback, which peaked at 65.8 in March 1985.

Enter James Baker III, treasury secretary from 1985 to 1988, who revived G-7 meetings to bring the dollar down. The Fed did all the heavy lifting, bringing the funds rate down to 6.7 percent in 1987 from 10.2 percent in 1984. Even so, by October 1987, however, the broad index was just down to 58.9 from the peak of 65.8 two a half years earlier.

The weekend before Black Monday, Oct. 19, 1987, Baker went on TV and threatened to devalue the dollar if the Germans did not do as he ordered on trade. Foreigners holding stocks or bonds denominated in dollars naturally ran for the doors. You had to sell fast before everything measured in dollars was suddenly marked down in marks or yen. Americans likewise rushed to buy foreign securities for the exchange rate windfall. After that rout was over, however, U.S. stocks and bonds were much cheaper to foreigners, and their prices went back up.

The broad index was barely affected by the G-7 feud, falling from 58.95 in October to 56.7 in December, and then rising once again to 72.1 by April 1990. Iraq's invasion of Kuwait and the simultaneous U.S. recession briefly pushed the dollar down to 68.4 by October 1990. Then the dollar started back up again.

By January 1993, when Lloyd Bentsen became President Clinton's first treasury secretary, the dollar was up to 81.1. Bentsen tried talking the dollar down at first, rattling the bond market but only tipping the dollar index to a low of 80.6 in April. Stung by criticism, Bensten began saying a strong dollar was good for America -- a statement often repeated by successor Robert Rubin. But the main reason the dollar started rising after 1995 was the U.S. stock market, including the investment hopes and dreams connected to the Internet and related equipment.

In March of this year, when U.S. stock prices were very low and bond prices very high, the Financial Times wrote: "About 42 percent of U.S. Treasuries are owned by foreigners, along with 26 percent of corporate bonds and 13 percent of equities. If these investors get the impression that the U.S. administration is abandoning the dollar, they may step up their hedging activity or, at worst, scale back their U.S. holdings."

For foreigners to "scale back" total foreign holdings of U.S. stocks and bonds, however, they have to sell them to Americans. Any foreigners who sold U.S. stocks to Americans at the March lows must be kicking themselves today. At last look, our broad dollar index was at 116.9 in October -- almost identical to the level of 117.4 in March 2000, before stocks began a three-year slide.

The dollar apparently rose even as the market crashed because the Fed held interest rates too high for too long. In any event, the dollar's current level is no more problematic today than it was in March 2000. Nor would it matter much if the dollar went up or down a bit, so long as it wasn't being driven by the wind from Washington.

Two lessons of postwar history are that (1) most of us should rarely worry too much about the dollar and that (2) treasury secretaries and presidents should never talk too much about the dollar.


Alan Reynolds

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