This summer's dizzying slide in the value of the dollar against the Japanese yen has stirred fears of inflation and a stock-market meltdown in the United States, creating expectations among some traders and analysts that if the dollar tumbles far enough, the U.S. Treasury would step in to stop it.
But would it really be that easy? Analysts warn that Treasury Secretary Lawrence H. Summers has limited powers to stop a dollar slide. He can try it through tough talk or a joint intervention with Japan in the currency markets. Success would depend on timing, psychology and, most importantly, many analysts insist, on underlying economic fundamentals in Japan and the United States.
If those economic trends are going the wrong way, analysts say, even currency-market intervention is a tricky strategy that could fail, causing both countries to waste large amounts of money in a fruitless attempt to pump up the dollar by buying the U.S. currency.
"Once you show up to intervene, there are lots of people on the other side just waiting to sell to you at these prices; then you have to back away," said Scott E. Pardee, who conducted currency-market interventions in the 1970s and 1980s as manager of foreign operations for the Federal Reserve's Open Market Committee. "It can be a rout." (When Treasury makes a decision to intervene, the Fed acts as the agent carrying out the orders.)
The question of what Treasury might do to bolster the dollar has been raised increasingly in recent days. The U.S. currency has sunk against the yen to its lowest levels in more than three years, putting it perilously close to what some analysts regard as the danger zone, where the dollar buys 100 yen or less. Down about 16 percent since May when it hit this year's high of about 122 yen, the dollar dipped below 104 yen for a while on currency markets yesterday.
"At this point it looks like the market is going to want to test 100," said Chris Widness, an international economist with Chase Securities who advises the firm's currency traders. "If we got below 100 it would be an extreme level."
Although there is no crisis yet, the matter looms as one of the first real tests for Summers since he succeeded Treasury secretary Robert E. Rubin in July. Rubin was widely regarded as a master of dollar policy, intervening twice in his 4 1/2 years as secretary, both times successfully. "Mr. Rubin was a magician," said Allen Sinai, chief global economist for Primark Decision Economics, who praised Rubin's sense of timing and determination to say so little that currency traders never knew exactly what he was up to.
Rubin's predecessor, Lloyd Bentsen, is remembered chiefly for the enormous power of a single comment that triggered a stampede in currency markets. Bentsen's almost offhanded remark in early 1993--"I'd like to see a stronger yen."--helped touch off a dollar slide that made U.S. exports cheaper but began a decline that culminated with the dollar falling as low as 79 yen in 1995.
Confidants say it was Summers who constructed Treasury's minimalist answer to all subsequent dollar questions--"a strong dollar is in the national interest"--but it is Rubin who gets credit for giving it credibility through endless repetition. Though Summers has repeated Rubin's statements verbatim, the currency markets aren't quite sure what he's made of.
"They're daring him to put money in, they're testing him," said Sinai. "So far he looks pretty smart to me."
In some ways, though, the weakening dollar is an inevitable byproduct of the nascent Japanese economic recovery that U.S. policymakers have been hoping for. Deeply worried about the lagging Japanese economy, which has been a drag on Asia's economic recovery, U.S. officials pressed the Japanese for growth-oriented policies. The Japanese responded, and one result is a stronger yen.
Economists and policymakers stress that the shifting yen-dollar ratio has more to do with a strengthening yen than a weakening dollar; the U.S. economy remains healthy and the dollar remains strong against other currencies, such as the euro. What's going on, they say, is a rebalancing of investment portfolios, as investors return to Japanese holdings they fled when the the country's economy went sour. Japan's Nikkei stock-market index has shot up nearly 36 percent since January. In the same period, the Dow Jones industrial average is up about 16 percent.
On the other hand, if the yen gets too strong, it could hurt Japan's economic recovery by making its exports more expensive. It also could batter the U.S. economy and financial markets: A weaker dollar means higher prices for U.S. consumers of Japanese products, which in turn would free U.S. manufacturers to raise their prices, triggering a surge in inflation.
Additionally, a rapidly sinking dollar could provoke foreign investors to dump U.S. stocks and bonds as their holdings lose value.
With Summers and other Treasury officials mum, it is unclear what it would take to trigger a U.S. intervention. But the most recent cases may offer some clues.
In June 1998, it was the yen that was weakening so rapidly that policymakers feared it threatened the global economy. At the market peak, a dollar bought 147 yen, and within days Rubin orchestrated an intervention that was accompanied by announcements that the Japanese would quit resisting U.S. pressure for more stimulative economic policies to jump-start their economy.
The combination of sudden intervention and changes in underlying policy helped reverse the yen's trend. Analysts predict that Treasury officials will demand similar policy concessions from the Japanese before there is any intervention this time. But with Treasury refusing comment, it is unclear whether officials there agree.
For many currency watchers, the classic intervention was the one Rubin orchestrated in 1995. The dollar had weakened, but Rubin waited until economic events--a decline in the U.S. budget deficit and an interest rate cut by the Fed--had begun to push the dollar back up. The intervention accelerated the dollar's climb and provoked the Wall Street Journal to label the move "brilliant."
In both cases, analysts insist, the key was the change in underlying policies; the interventions simply shocked traders, cost them some money and forced them to focus on the broader economic trends.
"Exchange rates are determined by economic fundamentals," said Daniel Tarullo, a former Clinton administration international economics adviser who is now at Georgetown University. "If the fundamentals don't allow you to intervene successfully, it is self-defeating to try."
CAPTION: Ripe for Intervention? (This chart was not available)