W. Germans Cut Key Rate, Then Send Dollar Reeling

As if moving a pawn on a chessboard, West German officials lowered a key interest rate by a quarter of a point Tuesday in an apparent response to Congress’ plan to trim the federal deficit, triggering a stock market rally and boosting the dollar. Then they made comments that raised doubts about their intent, sending a chill through the ebullient markets.

West German Chancellor Helmut Kohl told his nation’s parliament that Germany was prepared to “contribute actively” to international efforts aimed at economic growth and employment, but he added: “This cannot--and should not--lead to any drastic policy steps.”

The stock market and dollar soared in response to the action, which was coordinated with similar rate cuts in France and the Netherlands. Investors interpreted it as a long-sought signal that Germany was taking on greater responsibility for the world’s economic growth in the wake of the October stock market collapse.

But as a German official’s criticism of the U.S. budget cutting plan began to circulate later in the day, disappointment rippled through the financial community, and the dollar abruptly reversed course, actually ending the day lower than it started.

“The dollar went on a roller-coaster ride--up in the morning and down in the afternoon, and the bond market followed the dollar,” observed Irwin L. Kellner, chief economist at Manufacturers Hanover Trust Co. in New York. “It’s been an interesting day.”

The interest rate cuts were not the only mixed economic signals Tuesday. The government reported that the economy grew at a robust 4.1% in the third quarter, higher than projected. But it also reported a record-breaking trade deficit for that period, although the trade figures showed encouraging growth in exports.

Buoyed by news of the interest rate cuts and U.S. economic growth, the Dow Jones industrial average of 30 stocks gained 40.45 points, with the total value of U.S. stocks gaining 1.28%, or $30.29 billion, according to Wilshire Associates. The Dow closed at 1,963.53

For all the attention paid to Japan in recent years, West Germany has emerged as an economic colossus, leading the world with $243 billion in exports in 1986. U.S. officials have pressed it to stimulate its economy so that it would buy more from other countries, helping them to grow as well.

This would take pressure off the United States, which has powered the world’s economic growth but at the cost of a vast trade deficit. German reluctance, stemming from deeply embedded fears of inflation, is blamed by some as a contributing factor to the stock market collapse.

The European rate cuts were interpreted as a sign of improved international cooperation that might culminate in a meeting of the seven leading industrial democracies to deal with various financial problems, most notably the level of the dollar. The cuts came just days after congressional leaders announced a plan to trim $76 billion from the budget deficit over the next two years.

“The U.S. has met its part of the bargain, and the Germans have lowered interest rates,” observed John H. Green, an international economist with WEFA Group in Bala Cynwyd, Pa. “Now all the parties can come to the table.”

The German move seemed a sharp contrast to the days before the Oct. 19 stock market collapse. At that time, Germany’s interest rates were edging up, prompting an unusual public rebuke by Treasury Secretary James A. Baker III.

“Particularly with that background, the fact that they (German officials) are moving in a new direction is significant,” said Milton Hudson, a senior vice president and trade specialist at Morgan Guaranty Trust Co. in New York, who called the action “a very active, supportive gesture in the interest of world growth.”

Hudson and others said the cut--to 3.25% from 3.5% for a short-term rate used in extending credit--might herald further German rate reductions in the near future. In addition, the Bank of France and the Dutch central bank both cut key interest rates by a quarter of a point Tuesday.

Yet the remarks of a German financial official brought the dollar rally to an abrupt conclusion. Hans Wertz, a member of a policy-making committee on the German central bank, told a German news agency that the congressional budget plan fell short of U.S. commitments at an international meeting in Paris last February, and he suggested that the cuts be more than doubled.

“It was third-hand information, but the markets are so sensitive that it was enough to dump the dollar, which pulled the plug on the bond market,” Kellner said.

Responding to the German move, Rudiger Dornbusch, an economics professor at the Massachusetts Institute of Technology, said Germany was protecting its export industries: “They’re not doing us a favor when they try to keep the dollar from falling.” He said a quarter-point drop in interest rates “is not impressive by any means. It’s the smallest dose available.”

The dollar has lost half of its value against both the German mark and the Japanese yen since its peak in early 1985. While helping U.S. manufacturers compete against those nations, it also creates upward pressure on U.S. interest rates that can spread turbulence through the financial markets.

While the Paris accord was hailed as an example of international cooperation, some analysts now criticize it for setting unrealistically high levels for the beleaguered dollar. To maintain those levels against downward speculation, the central banks of Japan, Germany and other nations have bought $90 billion to $100 billion in dollars this year.

Moreover, Hudson said, expectations that the banks were merely holding off an inevitable plunge of the currency have had a “pernicious” effect on foreign investment in the United States, vastly reducing foreign purchases of U.S. Treasury securities.