SYNOPSIS: The continued strength of the dollar defies Economic explanation.

Everything about the American economy is down lately: manufacturing production, overall growth and, needless to say, stocks.

So why is the dollar still rising? At the beginning of last year, when everything seemed to be going right for the U.S. economy, the dollar was worth less than one euro, and only slightly more than 100 yen. Now everything has gone wrong — but the euro is below 90 cents and a dollar buys 125 yen.

Actually, I'm not surprised by the dollar's rise against the yen. We're nervous, but Japan is desperate; and since any recovery strategy in Japan will involve printing lots of yen, it will almost surely drive the currency down even further. But the continuing strength of the dollar against the euro is puzzling. In fact, it's downright weird.

Foreign exchange rates are, after all, determined by supply and demand. Americans supply dollars to the market when they seek to buy things foreign: goods like French wine, assets like shares in Nokia. Europeans demand dollars when they seek to buy things American: goods like Kansas wheat, assets like shares in Microsoft.

These days Americans spend a lot more on foreign goods than foreigners spend on American goods — that is, we have a large trade deficit, the largest trade deficit in the history of the world. Still, the dollar's strength a year ago was no mystery: the trade deficit was outweighed by the determination of foreigners in general, and Europeans in particular, to acquire U.S. assets and get in on the great boom. European individuals were buying the Nasdaq, European corporations were buying U.S. companies.

But who's buying dollars now? The tech bubble has burst; Daimler is choking on Chrysler; it's hard to imagine that either individual Europeans or their corporations still see America as the great land of opportunity. Yet somebody must be moving from euros to dollars.

At a recent academic conference I spoke to a German economist, Hans- Werner Sinn, who suggested the two best stories I've heard so far about the weak euro/strong dollar conundrum. Both stories depend on the peculiar status of the euro, which right now is only a virtual currency: there aren't yet any euro bills or coins in circulation. But in January the euros will arrive, and Europeans will start trading in their marks and lira for crisp new bills bearing pictures of bridges and monuments.

Mr. Sinn suggested that one group that may be moving from European currencies to dollars is criminals, Russian gangsters in particular. If you happen to have suitcases full of marks, and you don't care to explain where they came from, you probably don't want to walk up to a bank and exchange them for the new currency. Better to avoid accumulating marks and hoard dollars instead.

Innocent Eastern Europeans say, Polish farmers may also be shifting out of European currencies. Generations of bitter experience have taught them not to trust either governments or banks, and they may not be quite sure what this euro business is all about. Better to play it safe and stuff your mattress with a currency that isn't going through any changes.

I have no idea whether these offbeat stories can really explain what's happening. But they do suggest that the strength of the dollar and the weakness of the euro are temporary. In fact, you have to wonder why big speculators aren't shorting the dollar right now. Where are the George Soroses of yesteryear? Still, one of these days dollar holders may do a Wile E. Coyote: they will look down, realize that the currency has nothing to support it, and down it will plunge.

That wouldn't be a terrible thing: the weak euro has damaged European pride, but it has probably helped the European economy at a time when the European Central Bank has been stubbornly reluctant to cut interest rates. But then maybe the E.C.B. is inhibited by its belief that lower interest rates would weaken the euro.

And that may be the moral of our tale. It's a good bet that the era of the strong dollar will soon come to an end. That will be no tragedy; but it will be a problem if a falling dollar distracts the Federal Reserve from its duty, which is to ensure not a strong dollar but a strong economy.

Originally published in The New York Times, 3.31.01