Higher and higher it goes. The U.S. dollar's exchange rate yesterday set new records against the British pound, the French franc and the Italian lira. The dollar is riding higher against the German mark than at any time since the world abandoned fixed interest rates a dozen years ago and set currencies afloat to rise or fall with the tides of daily trading. The dollar is now 40 percent overvalued against the Japanese yen, in terms of the goods that it can buy.

Why the ultra-high dollar? The explanation begins with the early 1970s.

After the first great increase in oil prices, in 1973-74, the Arab producers suddenly found themselves holding huge amounts of cash. They put much of it in American banks that then recycled it to borrowers throughout the world who used it to pay their oil bills. It was profitable business for the banks, and, when the price of oil leaped upward again in 1979-81, bank lending expanded again. With the rapid spread of international banking, people in Europe and Latin America -- perhaps because they were pessimistic about prospects in their own countries -- chose to put their money in American banks. For a time that system worked well. The banks efficiently recycled the foreign money, sending it abroad in foreign loans as fast as it came in. By 1982, American banks were lending abroad at 30 times the rate of 10 years earlier. But in 1982 this gigantic recycling operation collapsed. The Mexican debt crisis revealed the strains on a long list of indebted countries, and the banks drew back. Their foreign lending dropped drastically, while the inflow of foreign funds continued. What did the banks do with the money? In 1983, as the American economy came out of the recession, a gigantic borrowing boom began here. The biggest borrower was the federal government, with its enormous deficits. But American businesses and consumers also were borrowing on a gigantic scale. Now the foreign money stays here.

Money coming into this country bids up the dollar; money going out bids it down. Because the cycle has broken down and inflow is no longer balanced by outflow, the dollar has risen. Over the past year, it has risen in a very big way. That creates a painful dilemma for the federal government. Its regulators don't want to press banks to lend more money abroad. It doesn't want to cut off the foreign money. It can't discourage borrowing, since it has become the biggest borrower of all. Federal policy is immobilized.

Meanwhile, the dollar keeps climbing. As it goes higher, the tension in the world's financial system rises. The point is not that the high dollar is good or bad, but that it's increasingly instable -- and an instable exchange rate can do much harm.