A major break in U.S. interest rates yesterday halted the dollar's long upward climb against most foreign currencies after it had reached record highs that caused a bitter reaction among European and Japanese officials and business people.
The dollar lost against the mark, other major European currencies, and the yen yesterday, while gold soared by as much as $25 an ounce in major markets.
But neither traders nor financial analysts were ready to say that the underlying long-term strength of the dollar was being reversed. In addition to the high level of American interest rates, which had created a favorable differential over foreign interest rates -- inducing investment here -- the dollar's strength had grown because it is regarded as a haven in a time of world uncertainty.
Whatever the pattern of interest rates over the next several months, that refuge aspect continues. The dollar thus generally is regarded as the world's safest currency.
Brookings Institution international economics expert Lawrence Krause said that yesterday's downward move, although sizable, "is only a little correction of a great exaggeration" of the dollar's value. "It would take many days like this" to bring the dollar back into a better relationship with other currencies, "and I don't expect it to go very far," Krause said. "The basic situation is that the dollar is still overvalued."
Former Treasury assistant secretary C. Fred Bergsten said, "it's too early to say" if the upward climb of the dollar is being reversed. Bergsten has deplored the dollar overvaluation against the rest of the world, which he estimated at 20 percent.
"We've had false starts before," Bergsten said. "But if the Fed is really turning toward easier money, exchange rates can turn around very fast -- you get a bandwagon response."
Krause, Bergsten and others who see an overvalued dollar as a threat to the world economic system point out that it makes imports into the United States cheaper, while making it difficult to export American goods. Bergsten has predicted that the loss of price competitiveness because of dollar overvaluation will cost $60 billion in the U.S. trade balance, cut the gross national product by 2 full points and eliminate 2 million jobs.
In a speech to the National Press Club last week, Bergsten said, "the international monetary system is riding for major trouble because the dollar -- still its key currency by far -- is riding for a fall. One cannot say when that fall will come." When it does, "the fall may be precipitous and severe."
One of the major elements behind yesterday's falling dollar was a Wall Street Journal story reporting that the Fed was ready to let the money supply expand more rapidly until the impact of new legislation relating to financial institutions becomes clear.
Financial markets took it as confirmation of other clues that interest rates are in a declining trend. Chief among these was a drop in the federal funds rate in New York by well over one percentage point to just over 9 percent. Most banks yesterday lowered their prime lending rate to 13 percent.
Against major European currencies, the dollar dropped about 1 percent, a sizable move for a single day. Eurodollar rates in London fell about half a percentage point to just above 10 percent.
In Tokyo, where the yen had sunk to a five-year low of 274 to the dollar earlier this week, the battered yen rose to about 270 -- still down about 25 percent against the dollar since the beginning of the year. Wire service reports said the dollar had gyrated wildly in active trading.
Late dollar rates in Europe compared with Wednesday were: 2.5197 marks, down from 2.5435; 2.1545 Swiss francs, down from 2.1880; 7.1390 French francs, down from 7.19125; 2.7555 guilders, down from 2.7805; 1,429.50 lire, down from 1,432.60; and 1.2334 Canadian dollars, down from 1.2388. By any historical standard, these are very low rates compared with the American dollar.
Treasury Secretary Donald T. Regan as recently as Tuesday explained the dollar's strength -- and the resultant weakness of other currencies, notably the yen -- as a consequence of the dip in inflation here at a time of "economic crisis" in Japan.
That brought a sharp retort from Bank of Japan Governor Haruo Mayekawa, who said such comments themselves make exchange markets highly unstable.
The increasingly strong dollar has posed a policy dilemma for foreign countries in the past two years, forcing them to choose between allowing their own currencies to depreciate or slowing their domestic rates of money growth.