Fix the dollar, and a lot of other problems will disappear — or at least be eased.
Fix the dollar, and a lot of other problems will disappear — or at least be eased. For example, the surging price of oil, which is acting as a brake on the U.S. economy, is highly correlated to the decline of the dollar vis-à-vis other major currencies.
As the value of the dollar versus other currencies has declined, oil — which is priced in dollars — has soared. Each time the dollar has shown any strength against other currencies, the price of oil has declined.
This suggests that strengthening the dollar is the quickest way to bring oil prices down to more reasonable levels, easing the strain on the economy, the threat of inflation and the nation's balance-of-payments problem.
But strengthening the dollar presents dangers, too, because the actions necessary to boost the dollar may hurt the economy in the short run.
Unfortunately, the dollar's weakness has been caused by a series of events and decisions that have placed the Federal Reserve Board in a very difficult position. In fact, the road to the current predicament has been paved with the Fed's good intentions.
Its decisions to lower the dollar's value go back at least as far as the East Asian financial crisis of 1997, when the collapse of the currencies of Indonesia, Malaysia, Thailand and others threatened the economies of Japan and South Korea, and even caused the U.S. stock market to drop suddenly.
The Fed, fearing that the world economy could slide into deep recession or even depression, eased U.S. monetary policy so the country would remain strong and act as an anchor against the slide.
It had to do more of the same in 1998 when Russia defaulted on its debts, causing the collapse of Long-Term Capital Management of Greenwich, Conn., and difficulties for European banks, threatening once again to plunge the world economy into severe recession.
All the liquidity created by the Fed helped inflate the Internet -bubble.
When that bubble burst, which was closely followed by the terrorist attacks of Sept. 11, 2001, the Fed stepped in once again.
Fearing that post-9/11 fright might lead to recession or worse, it again cut interest rates to stimulate the economy.
Afterward, whenever the Fed seemed ready to rein in the money supply, the specter of deflation reared its ugly head, and the central bank backed off.
This time, instead of technology stocks, real estate became the destination of the Fed's liquidity.
To head off the bursting of the housing bubble — an act which carried the very real danger of a financial system meltdown — the Fed found it necessary to increase liquidity once again, even if it preferred to raise rates and support the dollar.
The result has been high oil prices, an ever-increasing balance-of-payments problem and growing inflationary pressures as oil prices work their way through the economy.
Now the Fed is in a bind.
Raising interest rates would lift the dollar, which would bring down the price of oil, ease the strain on the nation's balance of payments and head off inflation.
It might also help improve the nation's dismal savings rate.
The rates on most savings vehicles are now so low now that it doesn't pay to delay consumption, especially with the inflation rate picking up.
But higher interest rates might just push a teetering economy into a recession — or at the very least delay recovery.
Higher interest rates also would cause the stock market to decline, at least in the short term, reduce corporate long-term investment, push housing prices down further and slow the housing recovery.
Nevertheless, the Fed should raise interest rates at its next meeting, even if only a quarter of a point.
That would stem the dollar's decline and likely would ease the threat of inflation.
The Fed should take the chance that such a move might push the economy into recession, for two reasons.
First, history has shown that countries can't devalue their way to long-term economic health.
Second, recessions often are necessary to clear excesses from the economy.
The Bush administration could help the Fed strengthen the dollar by telling the Department of the Treasury to support the dollar on the currency markets, and Congress could help by reining in federal spending.
Unfortunately, in an election year, the latter is unlikely.
For now, at least, it is all up to the Fed.
