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Falling Dollar a Mixed Blessing for Economy, Analysts Say

By Ian Johnson
The Baltimore Sun

Although European tourists have been enjoying unprecedented buying power on their grand tours of the United States, they may be the only immediate winners of the dollar's downward travels.

After the dollar hit all-time lows against the German mark over the past week, analysts are now concerned that the benefits of a weak dollar -- stronger exports and tourism -- may be more than offset by its disadvantages, such as more expensive imports and the threat of higher U.S. interest rates.

Another worry about the cheap greenback may be that its fall could trigger either higher interest rates in the United States or a further flight of foreign capital. The recent developments could also hasten the demise of the dollar as the world's most important reserve currency just as it celebrates its 200th anniversary.

The impact of the falling dollar may not be felt for about a year, economists say, because trade contracts are usually signed six to nine months in advance. This makes it unlikely that the cheaper dollar will cause a surge in exports and domestic production that will help the economy and President Bush's re-election campaign. Administration officials have tacitly welcomed a cheap dollar as a way to revitalize the anemic recovery before November.

And because the dollar has fallen so far -- falling 7 percent over the past two weeks to a record low of 1.3998 German marks Tuesday before closing at 1.4083 marks Friday in New York -- the Federal Reserve is now unable to drop interest rates further to help stimulate the economy without risking a further slide in the currency.

The immediate cause for the dollar's plunge is the difference in interest rates charged by central banks in the United States and Germany. While the U.S. Federal Reserve wants low interest rates to spur an economic recovery, the German Bundesbank wants high rates to control inflation. The resulting gap of 6 percent has caused investors to flock to mark-denominated securities in order to get the higher interest.

Until this past week, the administration and many analysts welcomed the weak dollar as an easy way to make U.S. products competitive internationally and end the current economic stagnation.

The usual argument for a cheap dollar runs as follows: If foreigners need less of their money to buy dollars, then U.S. products become relatively cheaper and so more are sold. This boosts production in the United States and creates jobs. Tourism also wins because foreigners, in this case Europeans, find it cheap to visit the United States. Americans, on the other hand, tend to keep their dollars at home because overseas trips become prohibitively expensive.

On the other hand, Americans may find that many favorite consumer goods and cars have become more expensive. The cheaper dollar can easily mean a price increase of $10,000 on German luxury cars although some manufacturers, such as BMW, are moving production to the United States to avoid these fluctuations.

"This is the flip side to the stronger exports. The manufacturers won't be the only ones to suffer, but also the car dealers and retailers who carry these products," said Cliff Milligan, an analyst specializing in the mid-Atlantic region at DRI-McGraw Hill, an economic forecasting company in Lexington, Mass.

The impact will be tempered, however, by the relative stability of the dollar against the Japanese yen, meaning that many household consumer products, such as stereos, cameras, VCRs and televisions, will not be affected by the past week's developments. The dollar has kept its value against the yen because Japanese interest rates are low.

More fundamental than the effect of the recent decline on one sector of the economy or another is the general lack of confidence in the dollar.

Many European investors, whose money helped fuel the stock market explosion of the 1980s, have become increasingly wary of investing in U.S. bonds or stocks because they fear that when the time comes for them to convert their dollars back into their home currency, they will be left with little. Some European investment managers have already started to unload all their dollar investments, part of an overall trend that has seen more than $50 billion in overseas investment leave the United States since 1988. During the eight previous years, $57 billion flowed into the country from abroad, according to the Securities Industry Association.

Although low confidence in the dollar could be cyclical and only reflect the difference between German and U.S. interest rates, other signs show that the dollar `s once-commanding position among other currencies has taken a permanent beating.

Spurred on by weak U.S. efforts to control inflation over the past 25 years -- wholesale prices have risen twice as fast in the United States as in Japan or Germany -- there has been a steady shift away from the dollar. The dollar's share of foreign-exchange reserves, for example, has fallen from 80 percent to 52 since 1975 and the number of countries that peg their currency to the dollar has shrunk from nearly 50 to 24.

More countries are putting their reserves in and aligning their currencies to a basket of currencies that includes the dollar but also the mark and yen. In the future, the European currency unit, or ecu, could be the biggest trading medium of exchange.

While such long-term trends do not explain weekly or monthly changes, they may provide the background to the unhappy anniversary of the "Mint Act" of 1792.