Strong Dollar, Weak Policy.

• Author: Bergsten, C. Fred

A harsh rebuttal to Bush Advisor Lawrence Lindsey's defense of a "strong dollar."

Lawrence B. Lindsey, President George W. Bush's chief economic adviser, affirmed and articulated in the March/April 2001 issue of The Internationlal Economy the new administration's endorsement of the "strong dollar" policy maintained by the Clinton administration since 1995. Secretary of the Treasury Paul O'Neill has reiterated the same position since experimenting briefly with an alternative formulation in February. Their doing so raises two fundamental questions: the substantive issue of whether a strong dollar promotes the national interests of the United States at this point in time and the meaning of the term "strong dollar."

A "strong dollar" has never been defined by the relevant officials and the mantra was indeed uttered both when the dollar fell to 80 to 1 against the yen in 1995 and when it soared to 145 to 1 against that same currency in 1998. Those same officials have always taken great care to avoid espousing a "stronger" dollar and never suggested that the currency should rise in value except when the formulation was first introduced in 1994. Nor did they do anything to strengthen it after their market intervention when it hit record lows in 1995. In fact, they sold dollars against the yen in 1998 and against the euro in 2000, all the while repeating the "strong dollar" rhetoric.

Hence there was never much substance to the "strong dollar" pronouncements. Nevertheless, their frequent utterances clearly comforted the currency markets and avoided the risk of embarrassment for Treasury officials. Thus, these pronouncements could be justified, pragmatically if not intellectually, during a period when an appreciating and even overvalued dollar in terms of the underlying international competitiveness of our economy, as reflected in the current account balance, was in the national interest of the United States.

The second half of the 1990's represented such a period. The economy boomed at a rate that clearly exceeded the growth of potential output. Unemployment fell to unanticipated lows, raising cost-push pressures. Inflation remained in check but there were widespread fears, as the economy continued to soar past all previous estimates of its "full employment" level, that price surges might be just around the corner. The Federal Reserve was under continuing pressure to tighten monetary policy (which Chairman Alan Greenspan and the Board, to their great credit, resisted far longer into the cycle than any of their predecessors would have dared).

Under these circumstances, a rising dollar and the growing current account deficits that it substantially exacerbated were useful safety valves. The dollar has certainly risen substantially: by 75 percent against the yen from its trough of 1995 to its peak of 1998 (by 50 percent to the level of June 2001), and by 70 percent against the DM and other key European currencies from 1995 until mid-2001. This currency appreciation directly reduced the prices of imports and, much more importantly, competing domestic products. The rising external imbalance, at the same time, provided the additional supply of goods and services that was essential to meet a domestic demand that was expanding much...