FEATURE-Intervention policy seen key to euro/dlr balance
01:32 a.m. Jul 06, 1998 Eastern
By Yoshiko Mori
TOKYO, July 6 (Reuters) - What if the euro keeps rising after its
launch, leaving the dollar far behind?
Such a scenario is quietly feared in Washington, and how the European
Central Bank (ECB) copes if it comes true will be the first test of the
new bank's credibility and the prospects for the euro, Japanese
officials and analysts say.
WHO INTERVENES IF MASSIVE CAPITAL SHIFT TO EURO?
A growing market consensus says the euro will strengthen early in its
life, prompted by a global flow of capital into Europe and away from the
U.S. dollar, traders say.
Former U.S. presidential economic advisor Fred Bergsten has repeatedly
said the euro will almost certainly become a major international
currency, boosted by substantial portfolio diversification even in its
early years.
Federal Reserve Bank of New York President William McDonough said last
month: ''We've heard that some investors have already begun to switch
some of their portfolios from a dollar-denominated one into either a
mark- or ECU-denominated one.''
The key question is which of the two -- the ECB or the US Federal
Reserve -- would intervene to moderate a euro rise if world capital kept
favouring Europe's single currency.
''I don't think the ECB would be naive enough to check the strength of
its own currency,'' Masao Suzaki, professor of economics at Tokyo's
Senshu University.
The ECB, in line with global forex market practice, would be likely to
tell the U.S. Treasury and the Fed that the nation with the falling
currency should act to defend it, Suzaki said.
ECB EXPECTED TO INHERIT BUBA'S POLICY
The market is also betting the ECB will inherit the intervention policy
of the Bundesbank, which is seen as regarding the strength of the mark
as a symbol of its power.
''If the ECB justified a euro selling intervention with the simple
argument that a cheap dollar could cause recession in Europe, it would,
in fact, spook the markets,'' said Takeshi Hanai, executive manager of
the Industrial Bank of Japan's International Treasury Dept.
A strong euro would contain inflation, while undermining the global
competitiveness of products made by EMU members.
But ECB President Wim Duisenberg said at his confirmation hearing at the
European Parliament in May that the future impact of exchange rate
changes on the European economy would be much less significant than it
is at present.
Trade with countries outside the EMU was seen as accounting for only
around 10 percent of total trade by member countries, he said.
The ECB also has the right to refuse to intervene in the forex market,
defying any calls to do so from politicians, if such intervention would
risk stoking inflation.
''The euro is like a huge aircraft carrier, as opposed to a group of
destroyers. Any quick, nervous moves in the forex market are quite
unlikely,'' Hanai of IBJ said.
JAPAN'S CRITICAL MISTAKE IN INTERVENTION POLICY
When it comes to intervention policy, the Bank of Japan (BOJ) offers a
lesson in what not to do, analysts say.
''The worst policy mistake Japan's monetary authorities have ever made
in their intervention history was let themselves be responsible for
defending the dollar when it fell relentlessly in 1995,'' Suzaki said.
The dollar hit a post-war low of 79.75 yen and fell to 1.3450 marks in
mid-1995. The BOJ then bought massive amounts of dollars for yen to stop
the U.S currency's freefall.
''There was no justification for Tokyo to defend the dollar at its own
cost when the huge U.S. current account deficit was then a major factor
in the dollar's weakness,'' Suzaki said.
This role reversal between Tokyo and Washington was one reason the BOJ
had struggled to retain market credibility as it tried to defend the
falling yen in recent months, he added.
It was only when the United States joined forces to intervene after the
dollar hit an eight-year high of 146.75 in June that the yen recouped
some of its dramatic losses.
U.S. FOREX WAR CHEST MAY NOT BE ENOUGH
Yet analysts point out that the United States may not have a big enough
war chest of foreign reserves to defend the dollar in the event the euro
overwhelms the U.S. currency.
The Federal Reserve Bank of New York said the Federal Reserve System had
$11.48 billion worth of marks in foreign exchange reserves at the start
of 1998, while the U.S. Treasury Exchange Stabilisation Fund had $5.81
billion worth of marks.
U.S. external reserves of $70.33 billion are ranked only the world's
seventh largest, after those of Singapore and Hong Kong.
''The next time a dollar crisis hits, the dollar will be forced to give
up its status as a key currency,'' said one fund manager at a private
asset management firm.
Analysts said the reason the United States -- the world's largest debtor
-- had so far avoided the kind of debt crisis suffered by Asia and Latin
America was because foreigners were willing to hold on to debt in the
world's leading currency.
Federal Reserve Chairman Alan Greenspan has said the cost to Washington
of funding U.S. government debt is reduced by $10 billion to $15 billion
each year because foreigners are willing to hold large amounts of dollar
debt.
U.S. DEBTS THREATEN DOLLAR'S GLOBAL STATUS
Former presidential advisor Bergsten has forecast the net debtor
position of the United States, which has already passed $1 trillion,
will shortly exceed $1.5 trillion.
In its annual report released in June, the Bank for International
Settlements said: ''the BIS is concerned that the markets will lose
patience with the accumulation of U.S. external debt and drive the
dollar sharply lower.''
Analysts say the launch of the euro may trigger a reversal in the
dollar's current strength to reflect huge U.S. debts.
But it could also spur the United States into taking action on its
economic fundamentals.
''The advent of the euro could motivate the United States to tighten its
fiscal discipline and to refrain from depending so much on foreign
capital,'' a senior BOJ official told Reuters.
Kosuke Nakahira, an advisor to the Institute for International Economic
Studies, said the U.S. current account deficit was unlikely to dethrone
the dollar from its key currency position overnight.
But the euro would certainly lighten the global responsibility the
United States currently bore, a burden perhaps heavier than was
warrented by the nation's economic power, said Nakahira, a former
Japanese vice finance minister for international affairs.
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