EU can’t swim if dollar sinks

Date: 24/05/06

Europe's response to what some suspect is a covert dollar devaluation strategy by Washington was an underlying theme of the spring economic conference of the European Commission's economic and financial affairs department held in Brussels last week (18-19 May).

Growth in the eurozone is threatened by what is already a 7% appreciation of the euro against the dollar this year.

Klaus Liebscher, the governor of Austria's central bank, is reported to be "unruffled" about the threat from dollar depreciation. Thierry Breton, the French finance minister, on the other hand said that the euro has risen far enough. "We must be very attentive to exchange rates," he said, adding "we will do everything" to try to prevent the divergence of the EU/US exchange rate from continuing.

While the two men apparently disagree, each might have been thinking about the same date: the 8 June meeting of the European Central Bank (ECB), when the governing council will discuss raising its key interest rate (probably to 2.75%).

Liebscher, a hawk on inflation, does not believe that the ECB should be discouraged from raising interest rates by the euro's strength against the dollar. Breton, on the other hand, may well have been trying to warn the ECB against a rate-rise.

In his presentation to the conference, Malcolm Knight, general manager of the Bank for International Settlements, the central bankers' bank in Basle, was not addressing such short-term considerations. He warned of protracted and painful consequences if the major players left the course of the world economy to market forces instead of managing the unavoidable and necessary reduction in America's still growing $800 billion (EUR 630bn) current account deficit.

Protracted because, as Professor Daniel Cohen of the council of economic analysis of the French prime minister pointed out, reducing global economic imbalances would require more than just a significant, short-term dollar devaluation.

The inevitable devaluation would have to be deep enough and last long enough, perhaps for ten years, to make it worthwhile for US businesses to reinvest in the production of tradeable goods for export, something they have not been doing. "This will be a major policy concern for EU policymakers. A severe external shock is looming," Cohen said.

Focusing on the short term, Economic and Monetary Affairs Commissioner Joaqu�n Almunia did his best to put a brave face on the outlook for the EU economy.

He stuck to the Commission's spring economic forecast that eurozone growth would rise to 2.1% this year. This was despite doubts about consumer spending, signs of rising inflation, the probability that a stronger euro and slowing US economy would hit vital EU exports and evidence that investors in global financial and commodity markets were ruing the end of super-low interest rates.

Cohen pointed out that the EU now seemed to be locked into a trend level of growth fully 1% lower than America's 3.5% and went through some of the economic explanations for this.

But it was left to former European commissioner Mario Monti and Angel Gurria, the Mexican who is secretary-general designate of the Organisation for Economic Co-operation and Development and was a key figure in the Mexican debt crisis of the early 1980s, to address Europe's torpid rate of growth.

Describing the euro as a "currency in search of a market", Monti launched a broadside against eurozone members France, Germany and Italy, for retreating from the EU founding fathers' very European (not, he stressed, Anglo-Saxon) vision of a market economy.

Resistance to the single market, whether energy market liberalisation or the "looting" of the takeovers and services directives, was most visible in these countries, he said. These states were also the worst offenders when it came to failing to respecting single market rules on state aid or transposing legislation such as the Financial Services Action Plan into domestic law. "At its heart this is a cultural problem. There is a growing unease about the market economy in these countries," he said.

Gurria rammed home the message. Intense competition led to innovation and growth, he said. But competition in EU sectors such as services, energy and telecoms was weak.

Strong tertiary education structures promoted growth, he said. But - although blessed with an abundance of brilliant minds - Europe's university education systems were inadequate.

The creation and destruction of companies promoted growth and innovation too, said Gurria. But this dynamic, he said, was weak in the EU. Governments, he added, had to stop promoting national champions, to encourage cross-border investment and remove obstacles to it. How could the EU argue for global economic liberalisation, in the Doha trade round for example, when it did not practise what it preached? Yes, the costs of reform came first and the benefits only later: that is why it was best to package reforms. It was easier to undertake them when your neighbours were reforming too and best to have your budgets under control since this sent out a message of confidence and commitment.

Even bankers such as Jim O'Neill, chief global economist at Goldman Sachs, are now going public on the markets' doubts about the ability of new Federal Reserve Board Chairman Ben Bernanke to handle a slow-down of the US economy at the same time as inflation which is rising faster than it has for more than a decade. US fund manager Bridgewater Associates wrote last week: "You have got a new, academic, waffling Fed chairman, a falling dollar, a falling bond market, rising gold and commodities prices and an under-performing stock market all with a giant current account deficit. Bernanke is rapidly losing control."

For their part, Europe's markets seem, correctly, to be signalling that the EU too may be about to pay a heavy price for economic policy mismanagement. Not incidentally by the ECB, which has been right to raise interest rates, but rather, as Mario Monti made plain, from a failure of political will which has left the eurozone economy inadequately reformed.

The EU is now exposed, simultaneously, to both the competitive challenge of globalisation and American economic unilateralism in the form of a covert dollar devaluation strategy.

• Stewart Fleming is a freelance journalist based in Brussels.

Major analysis feature in which the author says that US imbalances could see a long-term drop in the dollar against the euro and that Europe may pay a heavy price for economic policy mismanagement.

• Primary Source