The dollar steadied in 1988 after its sharp fall since 1985, but the currency may resume its decline in the new year due to fears surrounding the huge U.S. budget and trade deficits, economists say.
Concern that the global trade adjustment process is stalling threatens the dollar, as does skepticism over whether President-elect Bush will take quick, substantive steps to cut the federal budget deficit.Signs indicate that West Germany and Japan may be losing patience with Washington's efforts to narrow the country's deficits, which could undermine the policy coordination that supported the dollar in 1988.
The dollar fell 44.6 percent against the West German mark and 50.25 percent versus the Japanese yen from September 1985 - when the Plaza accord was reached to devalue the currency - to the beginning of 1988. The dollar touched record lows of 120.20 yen and 1.5615 marks on Jan. 4, 1988, in Tokyo.
But the dollar was supported by heavy central bank intervention early in the year, while an expanding U.S. economy and rising interest rates carried the currency through a summer rally.
The dollar peaked at 137.25 yen on Sept. 2 and at 1.9240 marks Aug. 9, the day the Federal Reserve raised its key discount rate, the rate it charges banks for short-term loans, to 6.5 percent from 6.0 percent previously.
But four months later, the dollar is closing out the year at about 126 yen and 1.79 marks, undermined by concern over the nation's twin deficits.
As for 1989, a robust economy and rising interest rates will boost the dollar early in the year, said Jonathan Greenspan of Aegis Capital Management Corp. But as the new year optimism fades, the dollar will hit new lows, dipping to as low as 110 yen and 1.55 marks, he predicts.
By year's end, assuming Washington has cut the budget deficit and narrowed the trade shortfall, the dollar should be 15 percent to 20 percent higher - at 140 yen to 150 yen and nearly 2.00 marks, Greenspan said.
Other economists share Greenspan's view. "I do think in the near term, the dollar is going lower," said Alan Lerner, managing director of Bankers Trust Co.
Lerner said that strong domestic consumption will keep imports high and the trade deficit large early in 1989. But by year's end, the economy will cool off, narrowing the trade gap and possibly boosting the dollar above current levels.
The U.S. budget deficit remains a major concern in world currency markets, and President-elect Bush received a two-edged greeting from world leaders after his presidential victory: a velvet glove of congratulations wrapped around an iron-fisted warning that he must cut the budget deficit.
Dealers said the dollar's subsequent fall was a warning of future events if the new president, who takes office Jan. 20, drags his feet on the issue.
"The major thing with the G-7 will be the budget deficit. There may be a power struggle over that," said Greenspan, referring to the group of major industrial nations.
The G-7 switched tactics over the year, said Andrew Hodge of Bank Brussels Lambert. Rather than intervening in the market to manage the exchange rate, the group now utilizes changes in domestic money supply and interest rates, he said.
The Bank of Japan ran a generous money supply while the Fed tightened credit in 1988, said Hodge. "The dollar is only where it is today because of this hidden support," he said.
But Japanese officials said recently they are quietly looking for ways to force the Bush administration to make quicker fiscal reforms, while Chemical Bank economist Warren Trepeta said Japan may have to run a less generous monetary policy next year.
In addition, the West German Bundesbank has tired of rescuing the dollar when market sentiment sours and the currency comes under attack, dealers said. West Germany welcomes the stronger mark to curb the mild inflation rise fueled by past rounds of dollar-buying, which puts more marks into the money supply, they said.
"I'm convinced that unless we see concrete steps to address the budget deficit, the Bundesbank will put its hands in its pockets when the dollar falls," said Robert Hatcher of Barclays Bank Plc.
"They have told the Fed and the administration, `Get your house in order, or we won't be there the next time the bottom falls out of the dollar.' "