Smart alecs flushed out as dollar goes down pan

Any chief executive of a European company which faces international competition at home or abroad who has not been preparing for the US dollar to fall sharply this year should be fired. The key question facing business and economic policymakers today is will the decline in the dollar - it hit a 26-year low against the once forlorn pound last week (18 April) - be orderly, or will the greenback pancake?

As long ago as 2001, when the US Federal Reserve Board began to slash interest rates in the wake of the collapse of the dot-com bubble, Alan Greenspan was telling his top aides that he prayed that as interest rates plunged the dollar would fall too. What better way to correct the growing imbalances in America’s foreign trade, which was already driving the US current account into deficit to over $400 million in 2000, than the classic adjustment strategy - a combination of currency devaluation and recession.

For reasons which are far from clear, but probably have something to do with China’s growth strategy (export to America and invest the proceeds in dollars to keep the Chinese currency from rising), Europe’s sluggish expansion and the rise in the oil price (oil exporters have also been buying dollars feverishly), Greenspan got only a mild recession and no dollar devaluation. So the US current account deficit eased back by only $25 billion in 2001 and has been soaring since. It hit close to $850bn last year. The recent devaluation, moreover, will at first tend to make the deficit worse as imports will cost more. Only later will slower domestic demand reduce imports.

What does this mean for the EU? Europe’s economic leaders have been guarded in their recent comments on the rise of the euro to within spitting distance of its all time high of 2004 and to record levels against the Japanese yen. The conventional view is that now the EU economy is growing under its own steam, rather than being powered primarily by exports, a rise in the international value of the euro is not as damaging as it might have been two years ago.

Indeed, José Luis Alzola of Citicorp argues that a stronger euro, because it reduces inflationary pressures (imports become cheaper and it is harder for domestic manufacturers to raise prices), implies that the European Central Bank (ECB) will not have to raise interest rates as much as now feared (a further 0.5% this year including a 0.25 hike in June) in order to keep inflation under control. Unlike a stronger euro, higher rates would directly hit consumer spending.

Despite the 3% rise in the trade-weighted value of the euro over the past three months, Europe’s exporters (led by world champion Germany) are still doing just fine.

The big issue is will the dollar decline be ‘orderly’, ie, a steady fall in the international value of the currency which will be conducive to a healthier world economy? Or will turbulence hit either the currency or America’s stock and bond markets, with feedback mechanisms both amplifying the distress and exporting it, notably to Europe’s financial markets which, as the International Monetary Fund has noted, are more closely entwined with America’s than ever before?

It is likely to be a close call and it is to be hoped that ECB President Jean-Claude Trichet and Fed Chairman Ben Bernanke are better friends than their two predecessors. The good news, however, is that all those smart alecs who called the euro a "toilet currency" in 2000, have long since been flushed away and the single currency, and its guardian in Frankfurt, are gaining daily in stature.

• Stewart Fleming is a freelance journalist based in brussels.

Any chief executive of a European company which faces international competition at home or abroad who has not been preparing for the US dollar to fall sharply this year should be fired. The key question facing business and economic policymakers today is will the decline in the dollar - it hit a 26-year low against the once forlorn pound last week (18 April) - be orderly, or will the greenback pancake?