TCS Daily


Hard Currency

By Jeremy Slater - March 18, 2004 12:00 AM

For Europe's two biggest countries, enough is enough -- at least when it comes to the euro-dollar exchange rate. President Jacques Chirac and Chancellor Gerhard Schröder have been talking lately about the poor state of their economies and how the recent strength of the European single currency against the dollar was not helping their attempts to create growth. Now they want something done about it.

Unfortunately, it's too little, too late. Even up until the beginning of this year very few statements had been made by anyone in authority, either in government or at the European Central Bank, about the euro's hitting new highs against the dollar. The greenback had been falling in value against the euro for over 18 months and yet no one had spoken of any potential problems until last month. In fact both Chirac and Schröder had signed a communiqué after the Group of Seven meeting in Dubai last September that suggested they were happy with the dollar's falling rate. So, guess what happened -- it kept on falling.

It was at just this sort of meeting where there could have been a chance to say to the Bush Administration that a high deficit and weakening dollar was not necessarily good for the world economy. Apparently such things were said at the latest G7 meeting in early February, but US officials rebuffed the claims by pointing to the weakness of European economy and saying that eurozone members had a responsibility to improve their efforts to create growth in the world economy.

Whatever the nature of the opinions expressed behind closed doors they certainly did not become part of an anodyne communiqué issued at the end of the meeting. In fact, the following was all the direction the world's greatest economic powers felt they needed to give to the financial markets: "We affirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely and co-operate as appropriate. In this context, we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas that lack such flexibility to promote smooth and widespread adjustments in the international financial system, based on market mechanisms."

And what happened to the relative values of the dollar and the euro after the Boca Raton confab? Absolutely nothing, which is why Chirac and Schröder finally felt they had to step into the fray.

The problem for euro policy so far is that it has been run by a European Central Bank that is too busy trying to establish its political independence, therefore ignoring pleas by politicians, and that pays far too much attention to inflation rates. The ECBs hawkish stance was part of the reason why it failed to cut its interest rates as swiftly as the US Federal Reserve Bank did in late 2001 and 2002. This meant that it missed out on a chance to boost eurozone growth at the same time as America boosted its own.

Even though eurozone inflation is fairly stable at around 2 percent and the euro keeping at a high level, the ECB still refuses to budge the rates. True, these are at a post-war low, but a cut would be something the financial markets and currency traders would take notice of and make the euro more attractive to buyers. Also with negligible growth in the core eurozone markets, France, Germany and Italy, lowering interest rates would have a beneficial effect on any green shoots of an economic recovery. The bank is caught between a rock and a hard place at the moment, hence the reason why it left interest rates at 2 percent at its most recent monthly meeting.

In the past the ECB has been criticized for a lack of transparency and puzzling the markets with decisions on interest rates that seemed contrary to other economic facts. With Wim Duisenberg, the former Dutch bank chief, gone, many observers had hoped that the ECB would become more robust in its policy decisions. Its new chairman, Jean-Claude Trichet, who is less phlegmatic than his predecessor, was hoped to give more impetus and coherence to the ECB's presentation, but so far he has not been able to put his stamp on the bank. He is also understood to be closer to Schröder and Chirac on the need for growth than his board members.

Unfortunately, Trichet first has to attempt to make the bank less hawkish on inflation and that can only take time. He must wait for members of the executive board's terms to end and then try to persuade national governments to pick new more suitable candidates. But he will have a difficult time influencing the appointment of any new heads of the national central banks, who make up on the ECB's governing council.

Which means that the prospect for eurozone growth remains gloomy unless Schröder, Chirac and Trichet can be more voluble in the need for the euro to fall. It would not be bad if the heads of other central banks agreed, but don't expect the Fed to do that in an election year and the Bank of Japan is more interested in nurturing Japanese growth than anybody else's.


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