Onwards And Upwards We Go

It’s no secret that the euro is now hitting record highs in its exchange rate with the dollar. It is also pretty apparent that some EU leaders are becoming rather preoccupied about the consequences of this for those eurozone economies which are driven by exports. What is much less clear though is what can be done about it.

The dollar early today was trading at $1.3065 per euro in Tokyo, signalling that the $1.30 psychological threshold may now lie behind us. Some experts are suggesting that the ECB would be reluctant to see the euro rise above $1.35, but since what is happening is more a dollar slide story than a euro rise one it is hard to see what they can effectively do about the situation.

Clearly this push-shove problem has been looming all year. Things seemed to get more relaxed in the late spring as comparatively strong US economic growth numbers distracted attention away from the problem of the liklehood of a continuing downward correction in the value of the dollar. The euro even fell back significantly and seemed to be happily hovering around the $1.20 mark. Now however this can be better seen for what it really was: a temporary respite on the road upwards.

The reasons for the dollar decline are also relatively well known: those dreaded twin deficits (trade and federal budget) and the continuing weakness in the US labour market. To be sure this latter situation has improved somewhat in the last couple of months, but it is still far too early to draw any definitive conclusions. I personally have my doubts that the recent momentum can be maintained as the impact of higher oil prices and rising interest rates make themselves felt.

Then there is the budget deficit. George Bush played mein host to a selection of top US bankers over at the White House earlier in the week in an attempt to reassure them that he was serious about reducing it. If he is, then obviously this will also act as another short term brake on the US expansion, and while in the longer run this would prove a plus for the dollar, the immediate consequence would be to encourage selling.

Up to now many in Europe have been cushioned from the full impact of rising oil prices by the upward movement in the euro, and Germany (Europe’s most export dependent economy) has managed against all fears to the contrary to ride out the storm (at least as far as exporting goes). But there is a limit to these benign consequences, and there will come a point where the negative impact will be all too apparent. It may well be that with both France and Germany now into a growth ‘soft patch’ that point is approaching.

So what could be done? European Union Monetary Affairs Commissioner Joaquin Almunia yesterday suggested – in a widely quoted interview – that the U.S. should help in avoiding sharp fluctuations in the currency markets.

“If the markets perceive or see that the political leaders and the economic leaders don’t want these sharper changes in the exchange rates, they will take notice of this message,” he is cited as saying.

This is to misunderstand the problem. Politically directed ‘talking up’ or ‘talking down’ may work in cases of short term fluctuations, but they can do little to prevent a long term correction.

US Treasury Secretary John Snow’s response was swift and to the point:

“The history of efforts to impose nonmarket valuations on currencies is at best unrewarding and checkered,” Mr. Snow said in response to a question on whether he would support an agreement with Europeans to manage the pace of the dollar’s decline. He made the comments after a speech in London.

In big picture terms Snow is undoubtedly right, although he himself has been trying hard over the past twelve months to disimmulate by repeatedly insisting that the US administration stood by a ‘strong dollar policy’.

Of course the ECB could respond by selling euros and buying dollars, ie by intervening directly. The Japanese did this earlier in the year, acquiring huge quantities of dollar denominated assets in the process, but to little real effect. It is unlikely than any such intervention by the ECB would fare much better.

Another possibility would be to lower interest rates, but with these already at historic lows of 2% there doesn’t seem to be much room to manoeuvre on that front either, especially since any prudent central banker would want to save some ammunition for later, just in case economic conditions should deteriorate.

So where does that leave us? Watching and waiting I suspect.

This entry was posted in A Fistful Of Euros, Economics: Currencies and tagged , , , , , by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

8 thoughts on “Onwards And Upwards We Go

  1. The ECB, and of course any other EU central bank that came in on the party, runs the risk of having all the other central banks whose past heavy intervention left them bloated with $ unload on them. Remember Richard Whitney after the Great Crash – he kept buying shares in his own firm, and everyone else kept selling to him, with obvious results.

  2. Everybody knew this was going to happen eventually. I hear the particularly sensitive German exporters are still hedged very well, including increased natural hedging in the case of car makers particularly.

    Maybe I’m going to write something about the German government’s council of economic advisor’s autumn report. They’re cautiously optimistic and are now bashing their natural allies in the opposition. That’s good news for economic politics and policy. Now the CDU/CSU will no longer be able to try to block in the upper chamber and blame it on the federal government. The blame is increasingly on them. On Tuesday, their health reform proposal got bashed extensively by the employer association… they will have to be less smug in the future.

  3. remember “The Dollar is our currency, and YOUR problem”.
    It’s pay back time!!!
    America above average growth was possible thanks to the FED printing money like hell.
    Now they hope the dollar going down will allow them to payback the loan with funny money.
    It’s going to be painful for the EU but wait to see waht could happen if China decide to unload this shitty currency. Interest rates will have to go up in the US and bye-bye the dream of “Grandeur”. In a dime the US status will switch from Hyperpower to Argentina.

  4. And when the US becomes Argentina, so will the economy of the entire world collapse.

    There’s an equal danger in being dependent on trade surpluses. You simply can’t let your best customers go broke.

  5. That’s true that you can’t let your best customers go broke, but you can extort and threaten them. China could let loose with just enough limp dollars to get everyone’s attention, then offer to make a deal. On Taiwan, perhaps.

  6. RSN,

    if history is anything to go by, the USA will, at some point, ‘become Argentina’. That is to say, it will have had its run, but some other nation will eclipse it.

    And the world’s economy won’t necessarily collapse as a result, so long as something else can replace the USA as the world’s dominant economic superpower. Perhaps this will be the EU (though I am sceptical of it); perhaps it will be China or India. Or perhaps it might be (say) Brazil; a laughable idea today, to be sure, but America’s run might well continue for another century or so, and who can say what Brazil will be like at that point? (Who would have imagined China or India as economic BSDs a century ago?)

    This is not criticism of America, much less anticipatory gloating. But nothing lasts forever. If America’s hyperpuissant star should one day decline, Spain and France and Britain (to say nothing of Rome and Macedonia) may be able to offer their old friend tips on adjusting to diminished status. In the mean time, I do hope its run will continue for a while. China or India might have the potential someday to displace the US economically. But I should not like to see them do so before they have evolved very considerably politically (especially in the case of China, but also to some degree in India’s case as well.)

  7. And this isn?t helping either
    from Bloomberg:
    “Greenspan Says U.S. Can’t Be `Complacent’ on Deficits
    Foreign investors will reach a limit in their desire to finance the U.S. current account deficit and eventually diversify into other currencies or demand higher U.S. interest rates, Federal Reserve Chairman Alan Greenspan said. The dollar extended declines against the euro and yen.”

    Thanx Alan!

  8. Remi said,

    “America above average growth was possible thanks to the
    FED printing money like hell.”

    No, the deficits have been financed by borrowing. The
    Treasury issues bonds and investors, often foreign governments,
    and in particular China, buy them.

    It’s always been obvious what’s going on. People always knew
    the bonds would be paid back in dollars worth less than what
    they were bought with. If governments have been willing to pay
    for these bonds then it’s because the perceived alternatives
    seemed worse. What would have happened if China hadn’t bought
    so many of these bonds the last few years?

    Then the dollar would have fallen already. US exports would
    have been considerably more competitive and imports correspondingly
    less. The U.S. trade deficit today would be much smaller.
    Chinese economic growth would not have been quite so
    rapid. The U.S. might have kept a larger manufacturing base than
    it has today. Much of europe might have gone into recession,
    and/or a deeper recession than already experienced.

    The point is no one has been fooling anybody. Unless
    they want to be fooled. Every proposed path has consequences
    good and bad. The big U.S. trade deficit has been
    propping up the world economy but the costs of maintaining
    that deficit are becoming unbearable.