Currency turbulence again
Short-lived turbulence again struck the international financial markets on Tuesday when the American dollar -- for the first time in over 50 years -- fell to below 100 yen. The dollar's tumble followed an official announcement that the U.S. trade deficit had increased by 22 percent to $8.4 billion in April and that its current account deficit had risen to $32 billion in the first quarter.
But, as later developments showed, the sharp dollar depreciation, notably against the Japanese yen, was caused mainly by speculative sentiments rather than the worsening of the American economy.
The dollar rose again to 101.50 yen on Wednesday after President Bill Clinton strongly asserted that the U.S. economy is healthy. Federal Reserve Chairman Alan Greenspan even considers the present U.S. economic outlook the brightest in decades.
We agree that the bouts of dollar depreciation and yen appreciation since last year were primarily caused by speculative sentiments. It seems traders have tried time and again to test the resolve of the central banks in Tokyo and Washington to prop up the dollar.
This time the wave of currency instability hit the market about three weeks before the G-7 summit in Naples.
Given the importance of exchange rate stability as part of overall monetary stability in preserving effective market economies, we wonder about the effectiveness of what the G-7 group of industrialized countries usually calls "policy coordination." The periodic waves of exchange rate volatility since last year give us the impression that the policy cooperation and the convergence of economic performance and fundamentals are no longer effective.
We don't think it is wise, despite the free, open-market mechanism, to allow the financial markets to go quickly from one extreme to another. Such turbulence not only causes market disruptions, but also adversely affects the flow of money and merchandise. Currency is a critical element in a country's competitiveness. The problem is that now, currency is increasingly volatile and explosive in its effects.
The U.S. fully realizes how damaging the impact of a highly volatile dollar on its capital market (stocks and bonds) would be. A further, sharp decline in the dollar would force the U.S. to raise its interest rates in order to make its fixed-income investment securities attractive to overseas investors. Otherwise foreign portfolio investment would fly out the door.
On the other hand, another sudden appreciation of the yen might cripple the beginning of economic recovery in Japan, the world's second largest economy, resulting in damaging repercussions on the other economies around the world -- notably the U.S. -- and the rest of Asia.
Indonesia, which now owes more than US$90 billion to foreign creditors, stands to receive double blows from a strengthening yen because 50 percent of its foreign debt stocks are denominated in the yen, while the prices of its oil and natural gas -- which together account for about 25 percent of its foreign exchange earnings and state budget revenue -- are in the American dollar.
We believe the latest wave of currency turbulence makes it more imperative than ever that the economic powers of the G-7 club focus the agenda of their forthcoming summit on working out a more effective mechanism to maintain exchange rate stability.