Paul O'Neill can scarcely get through a speech, interview or chat without having to say he still favors a strong dollar. Even though the no-nonsense US finance minister hates it, he's obliged to reassure everyone US currency policy hasn't changed.
For O'Neill, the exercise is the financial equivalent of "No honey, your bum doesn't look big." O'Neill has made it known that markets set currency rates and that the strong-dollar policy is a senseless and rhetorical device. It's more about satisfying traders than economic policy making.
Yet O'Neill also knows the fallout from admitting the policy is crap would be ugly indeed. It's like your partner asking you "Do I look fat in these jeans? Does my butt look big?" You may want to say "Actually yes, you're really porking up, darling." But the downside of honesty in such a case is massive. So you offer the white lie: "Of course not, you look great." It's the same for O'Neill where dollar policy is concerned.
He learned much about the risks of being honest in February 2001 when he said: "We don't follow, as is often said, a strong-dollar policy. In my opinion, a strong dollar is the result of a strong economy." The dollar went into freefall and O'Neill did weeks of damage control.
What's missing in all of this linguistic diplomacy is that sometimes a bottom is in fact too big for a pair of trousers -- regardless of what observers think. And sometimes a currency is too strong for its own good, making a nation's goods too expensive overseas and imports more attractive at home. One wonders if the US dollar isn't such a currency at the moment.
William McDonough, president of the Federal Reserve Bank of New York, hinted as much a few weeks back. While giving a speech in Washington, he said the US currency "is somewhat overvalued." McDonough validated the belief among some analysts that the dollar is stronger than economic fundamentals warrant.
If more investors begin to think this way -- or if the US Treasury begins favoring a weaker currency -- the dollar could be in for some rocky times. Ditto for Asia's currencies, especially the yen. Japanese officials want a strong dollar, which makes their goods more attractive in the US, their biggest market.
Why the dollar is so strong is hardly a mystery. Investors steered capital to the US because they saw nowhere else to go. Japan is still a basket case, while Europe is hardly a growth engine and its single currency remains frail. Argentina's mess, meanwhile, is scaring investors out of Latin America. That's left the US the most attractive of a weak bunch of economies.
This, for better or worse, has had an effect on other currencies. By acting like a huge magnet for global capital, the dollar is depriving other regions -- such as Asia and Latin America -- of much needed investment. Take South Korea, which is booming nowadays. Even with stellar growth and continued economic reform, investors aren't buying the won aggressively. One reason is competition from the US dollar.
The US isn't to blame for this. All economies try to get investors and capital to come their way, and Washington is doing what any other country would. There comes a time, however, when the most successful of policies outlive their usefulness.
The inflow of foreign capital was a force behind America's bull market in US stocks in the late 1990s and Washington is loath to reverse course. But at a time when the Bush Administration is slapping huge import tariffs on goods such as steel to protect domestic producers, a lower dollar could help.
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