Behind the Dollar’s Steady Fall in Value Lie German Nightmares of Inflation : Currency: When the interest-rate gap between Berlin and Washington is greater than 6%, even Aunt Tillie moves her money to get a higher return.

NEW YORK —  When a patient’s vital signs careen up and down, it is usually taken as a sign of danger. The recent sharp decline in the value of the dollar therefore catches the eye.

The problem is: No one is quite sure how bad, or even how good, a falling dollar is. Nor is there much that the U.S. government can do about it within the realm of political reality.

The dollar’s fall has been sharpest against the German mark, and the reason for that is not hard to find. German short-term interest rates have lately been steady at 9.75%; rates in the United States are just a hair over 3%. Even Aunt Tillie starts moving her money when the rate gap is that large.

German interest rates are high because two years ago German Chancellor Helmut Kohl decided to smooth the path of reunification by redeeming the old communist currency, the eastmark, one-for-one with solid capitalist westmarks. Everybody else in the world knew that three-for-one would have been a good deal for the Easties.

The conversion deal was a huge under-the-table welfare payment to the East. East German workers suddenly got paid in real money for doing considerably less than real work--much of it on the government tab, since the West Germans inherited all the old state enterprises. Germany, long the paragon of fiscal rectitude, was suddenly running budget deficits proportionally bigger than America’s. By the government’s own accounts, surely understated, the welfare transfer from West to East in 1991 was $90 billion, or about two-thirds as much as all East German output.

All those crinkly new westmarks chasing Michael Jackson records and Western shoes stirred the inflationary fears buried deep in the medulla of every German banker’s brain. Inflation topped 4% in 1991; West German unions, miffed at the sweet deal their erstwhile socialist cousins had cut, went on strike for more pay. So the bankers clamped down hard.

By driving interest rates so high, the Bundesbank, Germany’s central bank, hopes to dampen inflation by slowing economic growth. German industrial production and retail sales were down 4.5% and 6.8%, respectively, in the first half of this year. High rates also suck in money from all over the world to help balance Germany’s internal ledgers. The other major European countries, which have pledged to keep their currency values within a narrow, fixed relation to the mark, have been forced, quite unhappily, to raise their own interest rates to keep their currencies moving up, too.

The European upward march in rates comes at the same time that the Japanese have become major capital importers, to shore up their tottering banks and real-estate companies. If currency managers want to invest their money in Japan and Germany, they have to sell their dollar holdings and buy yen and marks. It is that selling pressure that causes the price of the dollar to fall, while the value of the other currencies rise.

Considering the extent of the interest-rate differential between the United States and the rest of the world, the dollar’s fall has been limited--about 10% against the yen over the past year, and 20% against the mark. That is why many analysts fear the slide could accelerate.

Is any of this important? That’s the tricky part. Politically, a falling dollar looks bad for the Bush Administration, because it suggests a lack of confidence in U.S. economic policy. In reality, it’s been many years since anyone abroad had confidence in U.S. economic policy. Currency trades, anyway, rarely think in such macroeconomic terms--for a money desk, “the long run” means next Tuesday.

The real effects of dollar devaluation show up in trade. A lower dollar means higher prices for foreign goods--bad for inflation fighters, good for, say, U.S. car makers. It also means more price-competitive U.S. exports, so the American trade deficit should fall even farther. Except for the pained expressions on the faces of American tourists when they get their hotel bills, however, none of these effects will show up much before winter.

The big fear for George Bush is that currency jitters could spook the stock markets, as they did in October, 1987. Bill Clinton supporters must be praying for just such an event, followed by the same quick recovery we saw five years ago.

But there’s not much the President can do but wait and hope. The only way the Administration could raise the dollar’s value any time soon would be to start pushing up U.S. interest rates. There is no chance of that in an election year--nor any good fundamental reason to do it.

The real casualty from the Bundesbank’s take-no-prisoners approach to monetary policy could be European economic unity. One of the main fears of the anti-unionists is losing control of national economic policy to the Germans.

Nobody pretends that a European central bank would not be dominated by German attitudes toward inflation and monetary policy. That’s the whole point. To consistently profligate nations like France and Italy, a Germanized European central bank is tantamount to an American balanced-budget amendment--a way for politicians to protect themselves from their own baser impulses.

But German interest-rate policy is putting the hard-won political unanimity behind Europe’s economic union to a sore test. Voters in Denmark have already refused to ratify the Treaty of Maastricht, the official blueprint for economic integration. The French vote this month. A few months ago, the French referendum looked like a sure thing. But recent polls show a dead heat between the pro- and anti-unionists. The union can survive a no vote by a small country like Denmark, but not from France. The specter of German economic bullying feeds directly into French nationalist fears.

In purchasing-power terms, the dollar is undervalued somewhere between one-quarter and one-third against the mark and yen, so at some point it will start rising again, but not soon. The good news is that eastern Germany has fewer people than California, and a much smaller economy. Kohl’s promises that the East will be fully absorbed by 1994 could come true, letting Europe and the currency traders get back to a normal business.