The finance ministers and central bankers of the Group of Seven industrial nations this week in Washington confirmed their desire for a stronger U.S. dollar.
Although still a favored reserve currency, the US$ has been shaky in recent months and lost ground against the yen and the German mark. More recently it has recovered some of this ground against both currencies. At the Washington meeting, the ministers and governors indicated they were ready to intervene in the foreign exchange markets again to support the dollar.
A communique issued after the meeting said the G-7 welcomed ``the orderly reversal in the movements of the major currencies.'' The ministers and governors ``reaffirmed their commitment to reduce imbalances and to co-operate closely in exchange markets.''
As noted before in this space, such intervention has proved effective in bolstering the dollar despite the conventional wisdom that central banks are powerless to thwart the will of the market if it turns against a currency.
The key to successful intervention has always been not only a firm resolve by the G-7, but a commitment to act vigorously when the dollar reached a pre-determined point of value.
Setting a trigger point does not mean the G-7 has some magical power to divine what the ``proper'' value of the US$ should be. Even U.S. Treasury Secretary Robert Rubin declined to specify where he would like the dollar to settle. But there is little doubt that all the G-7 share the view of Deutsche Bundesbank president Hans Tietmeyer that the present value of the dollar ``is not fully reflecting the fundamentals of the situation.'' The Japanese finance minister also said there was room for the dollar to rise further.
The US$'s strength and stability is much more than a matter of pride to the Americans. Already this year the market signalled the results of a falling dollar: long-term interest rates jumped and bond prices fell sharply.
If the market were really to smell blood in the absence of evidence of central bank support, the upheaval in the market would put the stability of the international financial system in jeopardy. Although the yen and the mark have appreciated against the dollar there is as yet no clear evidence that these two currencies can absorb a massive flight from the dollar.
It is therefore clear that along with a commitment of co-operative support for the dollar, the U.S. itself must focus on policies that will increase the demand for the currency and diminish the comparative lure of the yen and the mark.
Tax reforms of the type proposed by some of those running for the Republican presidential nomination would boost confidence in the dollar. For example, a flat-rate income tax and the reduction or elimination of the capital gains levy would make dollar-denominated investments more appealing. Wiping out the U.S. budget deficit and starting to pay down the debt would reduce government borrowing and ease upward pressure on interest rates.
It is also important that the Federal Reserve avoid trying to fine-tune the economy by frequent fiddling with interest rates. As Robert Lucas, announced this week as winner of the Nobel Prize in economics has noted, it is more important for the central bank to focus on long-term goals such as price stability.
A package of such fiscal and monetary policies would on its own restore confidence in the dollar and help smooth out the gyrations in the foreign exchange market.
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Revised: May 10, 1996
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