View of Euro from London Financial Times
The Long View: For a few euros more
news.ft.com
Europe is frustrated by the dollar's rampage but opportunities loom, writes Barry Riley
Published: July 13 2001 14:46GMT | Last Updated: July 13 2001 16:06GMT
It is high summer and the currency markets are wobbling
unsteadily in the heat, as is their tendency at this
season. In particular, the strength of the dollar has
progressed from being an anomaly to what is perceived
as a destructive influence.
True, the dollar's trade-weighted index has eased down
a little in the past few days, having hit a 15-year high last
week. But the dollar has climbed by 39 per cent in six
years, or 5.6 per cent a year on average, and its rise has accelerated with a gain of
15 per cent in the past 18 months.
Unusually, Sir Edward George, governor of the Bank of England, made a public
complaint this week, saying the dollar's almightiness was damaging the US
economy and contributing to the inflation problem in the euro-zone. He seemed to
be doing a favour for the euro-zone, in saying things that the European Central
Bank would rather not utter itself.
But the ECB is very frustrated over the dollar's rampage. And we can easily
understand how much more bitter the Argentines feel about it. They rashly
decided several years ago to stabilise their economy by hitching the peso to the
US currency. But the dollar's relentless appreciation is tearing Argentina's
economy apart, and this week emerging market bond investors raised the interest
rate for financing the country's debt to well over 20 per cent. A familiar group of
usually suspect economies, such as those of Turkey and Brazil, is being sucked
into a new crisis of second-line currencies.
Adopting some other country's currency without any mutual agreement on policy is
very dangerous. Such a blunder led the UK into deep trouble in the early 1990s
when Germany, which was overheating after reunification, set the interest rates for
the European exchange rate mechanism.
Now we cannot expect the US government to have any concern for Argentina's
economy when it appears to have little regard for its own. Grave damage is indeed
being done to American domestic industry, with manufacturers complaining
bitterly about the strong dollar policy. But the idea that exchange rate policy should
be designed to favour domestic companies has become out-of-date. The global
economy may be slipping towards recession, but we are still a long way from the
beggar-my-neighbour devaluations of the 1930s.
Rather, the US government has found the dollar's strength to be a convenient way
of suppressing inflation - probably by more than 1 per cent annually in recent
years. Some of that inflation has, in effect, been exported to the euro-zone.
Anyway, a firm exchange rate is vital to retain the confidence of holders of the vast
quantities of $100 bills and dollar deposits around the world. This is nominally
free financing for the US, which is the world's biggest debtor nation, but there is a
price to be paid. The dollar must be regarded as a strong currency. Otherwise
something like $2,000bn of hoarded dollars might go on the move.
So the prospect of the cheeky Europeans tapping into this hot money pool next
year, when high value E500 notes become available, has irritated the Americans
and is worrying the international crime fighting agencies. More than four times the
value can be packed into a suitcase or a mattress. But the euro, in its first 2½
years of life, has come to seem a risky currency to hold - although it is reassuring
that recently it has stabilised above its October 2000 low of 83 US cents.
Cash may be technologically obsolescent but it retains the crucial advantage of
anonymity. Currency analysts are closely studying the implications of euro note
issuance. Vast quantities of old currency notes are held in Europe, especially in
Spain and Italy, either illegally accumulated through the black economy, or maybe
just hoarded. But the peseta, the lira and the rest will cease to be legal tender at
the end of February, 2002. The black economy will be forced out into the light,
unless it can devise some evasive manoeuvres.
In fact part of this hidden hoard is being laundered, especially through the property
market. But if the suitcase savings are being converted into $100 bills, in a
pre-emptive move into safer assets, part of the euro's weakness this year against
the dollar could be explained, especially if the Mafia is heavily involved. And it is
quite likely that next year the money will be quietly switched back into euros,
generating equally unexplained strength in the European currency. The
conversion of more than E600bn worth of notes and coins held by some 300m
people is an unprecedented event which could be generating a financial
earthquake.
A possibly more important explanation for the euro's softness, however, probably
arises from the booming euro-zone bond market, which has been heavily tapped
by US companies and federal agencies. To the extent that capital has been raised
in euros and sent across the Atlantic in dollars, for instance to fuel the explosive
US mortgage market, the dollar has been strengthened.
The activities of the Japanese are also significant, if low-key. On the one hand,
Japanese financial institutions have been disillusioned sellers of
euro-denominated paper, with the proceeds being repatriated. But more recently
the Japanese authorities have been intervening and supporting the euro, as part
of their policy to hold down the yen.
Meanwhile, the bears of the dollar are stirring. The huge imbalances being
generated by the US economy have been accommodated with surprising ease so
far, but the strains are showing, especially in cutbacks by the corporate sector.
There is trouble in Latin America and Turkey, and Asia is heading into another
slump only three years after the last one: the latest second-quarter figures from
Singapore show a decline in GDP of 6 per cent from the peak level in late 2000.
The last time the global economy wobbled, in 1998, the US recycled vast
quantities of dollars through the IMF to countries like Indonesia, Russia and
Thailand. The dollar faltered then, and if the policy were to be repeated in the near
future, with the current account deficit stretched out to $400bn, the US currency
would be much more vulnerable.
When it was launched amid all those balloons at New Year 1999 the euro
seemed to offer great appeal as a diversifier of currency risk. It missed its first
chance. But it may soon have a second opportunity.
Contact Barry Riley |
