The strong dollar, long the target of bitter complaint from abroad, is now hurting U.S. industry and employment.
Officials expect it to lead to a gaping trade deficit this year, hurting U.S. exports and aiding imports, and thus eating into the strength of the economic recovery now under way.
The dollar's dominance over other currencies has stirred a top level international debate over currency intervention--when governments buy and sell currencies in the foreign exchange markets in an attempt to influence the values of the currencies in relation to each other.
This country's allies in Europe and Japan would love to see the United States intervene to try to make the dollar weaker. They were encouraged by the recent statement by Federal Reserve Board Chairman Paul A. Volcker that intervention "may . . . have a modest but useful" role to play.
But Treasury Secretary Donald T. Regan reiterated on Friday that the administration remains opposed to intervention in the foreign exchange market except on extremely rare occasions, and then only to counter disorderly markets or extreme exchange rate volatility.
Regan spoke at the release of a study by the seven summit nations of the industrialized world, claiming that the study backed the administration position. The French--who are most in favor of joint intervention to bring currencies into line--believe that the U.S. refusal to intervene heavily in foreign exchange markets is part and parcel of its failure to use its economic power to lead the world out of recession.
The working group that prepared the study, senior monetary officials from the United States, West Germany, France, Canada, Italy, Japan and Britain, did not spend much time on the fundamental issue of what governments are trying to achieve when they go into the foreign exchange markets.
Instead, it concentrated more, in the words of one expert, on the narrower issue of whether "we have a separate policy tool that is called intervention," and, if so, how effective that tool is.
One part of the U.S. argument against intervention is that if authorities buy and sell currencies in such a way as to leave monetary policy unchanged, then experience suggests that they will have only a limited impact on exchange rates. If, on the other hand, they allow the intervention to affect monetary policy then the impact can be very much greater. But in that case it is hard to work out how much of the effectiveness is due to the change in monetary policy and how much to the intervention.
Moreover, if governments are content to change monetary policy in order to influence exchange rates, they may as well do that directly rather than indirectly through intervening in the markets, the U.S. argument goes. And if they are happy with their domestic monetary and fiscal policies then they should not try to interfere with the market's judgment about their currency rate. In the end, exchange rates will be determined by the huge private currency markets according to fundamental factors of inflation, trade flows, interest rates and so on, Treasury officials say. Intervention is just not a strong enough tool to outweigh these factors, they say.
The study, however, suggests that intervention can be far more effective than administration officials say. It does not, in the words of one expert, "make a case for everyone to go their own way on monetary policy and fix it up with intervention."
But it does say that intervention can increase the effectiveness of other policies, particularly monetary policy, and can achieve several limited, short-term goals such as slowing rapid and volatile currency movements and protecting a psychological benchmark for a currency, which if broken could set off a bandwagon movement that might not reflect underlying economic conditions.
The study also shows that if governments coordinate their action in the foreign exchange markets it is generally more effective. But as governments discuss with each other whether or not to undertake coordinated intervention, they are likely to be led back into the question of what they hope to gain from it.
One possible objective is greater exchange rate stability. Although the research evidence so far does not suggest that variable exchange rates are damaging--they do not appear to inhibit trade, for example--many people "are not sure that the last word's been said" on that, one expert said. Even Regan complained this week that exchange rate volatility was damaging to world economic health.
The other, more ambitious, aim of heavy intervention is to correct what are perceived as "misaligned" exchange rates. This of course begs the question of whether governments or markets are the best judges of correct exchange rates. Many experts would probably agree with Volcker that "from time to time it may be possible for governments to reach a consensus on when exchange rates seem clearly 'wrong.' " But such thinking runs counter to the administration's free market philosophy.
There is a further use for intervention--as part of a wider exchange rate policy. For some nations at some times, domestic policies are tailored at least partly to achieve a particular exchange rate.
Even if this is not the case, as in the United States now, there is an argument for using exchange rate movements as a guide to what changes may be appropriate in domestic policy. If, for example, a currency is persistently weaker than the government would like, this may suggest that domestic policies are too loose. "Exchange rate movements can help 'tell us' something useful," Volcker said. Finance ministers of the seven summit nations agreed to watch exchange rates as a guide to needed changes in domestic policy.
The reasoning behind this helps explain the French accusation against U.S. exchange rate policy. The strong dollar is an indication, some would say, of excessively high U.S. interest rates and over-tight monetary policy.
The administration's refusal to intervene to bring the dollar down is thus akin to its refusal to bring down interest rates or take the lead for pulling the world out of recovery. Administration officials in turn can argue that the French support for intervention avoids the real issue behind the weakness of the French franc, which is that French economic policies until recently have been too inflationary.
Disagreements over currency intervention can therefore sometimes reflect deeper disagreement over broad economic objectives, rather than more technical disagreements over how best to achieve them.