Leading Article: A little midsummer market madness

ON THE face of it, the upheaval in the foreign exchange markets looks like an old-fashioned currency crisis. The dollar has declined against the Japanese yen to its lowest level since the end of the Second World War. That is an easy enough benchmark to generate headlines and soul searching. The American currency has also fallen sharply against the German mark and the Swiss franc, supporting the idea that investors fearing inflation in the United States are seeking safe havens for their funds.

Yet there are curious aspects to this apparently simple set of events. It is a tribute to the confusion over global indicators that only a few months ago all the talk was of an undervalued dollar. Investors were meant to be bullish about the currency, and they all seemed to be, but somehow it never came about.

Then analysts began to speculate about the Clinton administration and its stance on inflation. Would US interest rates rise ruthlessly to choke off a rise in prices as recovery took hold? Or would a Democrat prefer to suffer a gentle dose of inflation rather than spoil the public's perception that things were getting better after a fierce recession? President Clinton and his team managed to send signals that did not clarify their position with sufficient rigour for the markets. In vain they argued that the dollar's fundamentals were sound, that America's economic health was good and that their resolve to fight inflation was strong. It was pointed out that the Federal Reserve was unlikely to raise interest rates sharply, believing that economic growth was well-founded and prices under control.

But the markets' preference for historically sound currencies speaks of instincts which outweigh mere considerations of interest rates. Nobody ever got rich simply by placing their deposits with a Swiss bank, whose rate to depositors has seldom been generous. But few have lost out by doing so.

Thus the nervousness about inflation feeds into doubts about bonds and equities, nourishing the volatile uncertainty upon which the nervousness began. This cycle of doubt may well be overstated. Just as the markets perhaps too readily accepted the nostrum that the dollar must rise, they may be too simplistic in accepting the reverse.

There is every sign that the Federal Reserve's cautious tightening of monetary policy is appropriate. Logic seems to state that the markets are witnessing a typical overshoot, not a fundamental reassessment of the American economy.