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The Weakness of the Strong Dollar

It is always risky to write about exchange rates. If a currency's exchange rate is falling, it may well be rising by the time one's article appears. But the issue of how we should think about exchange rates and their appropriate management is a perennial one.

So what is at issue now is not just the falling dollar, but rather what US officials intend to do about it. Paul O'Neill, the outspoken US Treasury Secretary, suggests that there is little the US could or would do to sustain the dollar. His remarks were criticized by some as abandoning the strong dollar policy that was the Clinton Administration's hallmark.

One responsibility of economic leadership is to dispel economic myths--certainly not to create them. The "strong dollar" policy represents an especially egregious example of an economic myth; it seems to suggest that the US Treasury could, and would, maintain the strong dollar, and that a strong dollar is good for the US. When I was chairman of the President's Council of Economic Advisers, I was often asked if I supported the strong dollar policy. I replied that I believed in an "equilibrium dollar."

In other words, exchange rates are no different from other prices. Like the price of apples and oranges, market forces should determine them. Anyone who says he believes in a "strong orange policy" would be ridiculed. Yet some of those who seem to have the greatest faith in market forces treat exchange rates as if they were governed by laws other than those of standard economics, so that a word or even a look from a finance minister could lead currencies to soar or plummet.