How The Dollar Falls and Gets Rescued

1 Tokyo Corp., a Japanese exporter, gets lots of dollars because it sells so much to the United States. To operate its factory in Japan, it needs to convert its dollars to yen. Its local bank gives Tokyo Corp. yen in exchange for dollars and then looks for someone to buy the dollars. The bank’s currency trading with other banks actually takes place in the form of securities--U.S. Treasury bills in exchange for similar securities payable in yen. Such dollar sales, and many others like it, help depress the dollar’s value.

2 Multinational Corp., another Japanese company with extensive operations worldwide, concludes that the dollar is going to keep falling. To protect itself, it too tries to unload dollars, using a computerized trading operation to find buyers all around the world.

3 With more sellers than buyers, the dollar’s value drops until the price is low enough to attract enough buyers.

4 Corporate counterparts in Frankfurt and other European financial centers, and then the United States, join the bandwagon. XYZ Corp., a U.S. company that plans to build a factory next year in France, figures the dollar is going to keep falling and decides to buy now the francs it will need next year. Through its bank, it puts out orders to sell dollars for francs.

5 U.S. stock and bond markets fear the declining dollar will prompt the Federal Reserve to raise interest rates in an effort to make U.S. Treasury notes and bonds more attractive to foreign investors. Higher interest rates and a declining dollar could mean greater inflation and slower growth for the U.S. economy.

6 U.S. Treasury officials decide to take countermeasures. After consulting with the Federal Reserve, the Treasury issues orders for the Fed to buy dollars. The two work out together when--and how heavily--the Fed should be buying.

7 Almost immediately, the trading desk on the seventh floor of the New York Federal Reserve Bank, which conducts all foreign exchange operations for the United States, begins discreetly calling a few commercial banks to warn that it will be buying. The hope is that a warning alone will have a positive effect.

8 If that does not work, Fed traders place bids for the purchase of dollars. They go through the same process as those at the private banks--calling bank trading desks with sizable orders. As the supply of available dollars shrinks, the dollar’s value stops falling and may start to rise.

9 If the dollar does not stop falling, the Treasury calls on its allies to help. Finance ministers and central bankers of the countries in the Group of Seven--the United States, Japan, West Germany, Britain, France, Italy and Canada--have already established upper and lower limits for the dollar’s value and have set up a mechanism for coordinating intervention in the markets. In most cases, the mechanism can be activated with a conference call to agree on the timing, size and scope of the intervention.

10 The strategy is to use as little firepower as necessary. That way, if more dollar-buying is needed later, there will be plenty left in the kitty to carry it out. Although together the central banks can easily outbid any single market player, the $150 billion a day that swirls through the currency markets sometimes can overwhelm them. As a result, their success depends on skill, timing and--occasionally--intrigue to keep the markets off balance.