>I was hoping someone could elucidate an issue I've had a little trouble
>understanding. In his new book, Peter Gowan argues that the U.S. has used
>the international status of the dollar as an economic/diplomatic weapon, and
>he occasionally mentions the demise of the Mitterand experiment as an
>example: the U.S. kept the dollar high in order to sabotage French efforts
>at reflation.
>
>But as far as I know, a country has only two ways to manage its exchange
>rate: interest rates and forex market interventions. But interest rates are
>controlled by the independent Fed, not the Treasury. So does that mean that
>"Dollar Diplomacy" is conducted exclusively through open-market currency
>purchases? Aren't there limits to the effectiveness of this tool? And does
>that mean that such notable examples of exchange-rate management as the
>Plaza agreement and the post-1995 high-dollar policy have been executed
>exclusively through forex purchases?
By law, the Treasury controls dollar policy. It's the only area where the Fed is required to march to the elected government's music.
But that's figuring dollar policy narrowly - interventions, which are rare (and on which the Fed and Treasury actually make a profit, despite market declarations of their futility). The early-80s dollar strength was determined by larger forces, like high interest rates and a perception that Reagan's U.S. was a great place to invest. If you were a portfolio manager, where would you park your money, in a U.S. committed to deregulation and disinflation or a France committed to regulation, nationalization, and reflation? The relative fates of the dollar and the franc in the early 1980s were at least as much symptoms as they were causes of anything - symptoms of capital movements.
But that couldn't last forever: the high dollar was savaging U.S. exports, and Reagan had won the policy battles on a world scale. So the Plaza agreement was a nice psychological catalyst for a shift in currency values that was in line with the fundamentals.
Doug