The U.S. Dollar: Our Currency, Europe's Problem
In 1971, then U.S. Treasury Secretary John Connolly told his European counterpart: the dollar is our currency but your problem. Fast forward to today and Mr. Connolly's statement still rings true. As the buck has slumped this year, the euro has become a favorite alternative to foreign exchange traders and central banks. The holdings of euros among central banks rose to a record in the second quarter of this year, with the euro accounting for 27.5% of global currency reserves. While not yet a serious rival to the dollar, the euro's global stature has increased over the past year. That is the good news.
The bad news - the euro's strength comes at an unpropitious time for Europe since export growth lies at the heart of continent's nascent economic recovery. The stronger the euro, the greater the pain for European exporters and many export-depend nations across the continent. To this point, in the final quarter of 2008, net trade subtracted more than a percentage point of the eurozone's total output. It was the collapse in global demand that decimated Europe's leading exporters last year. Additional pain has come this year courtesy of a stronger euro, with the euro roughly 20 percent more expensive in dollar terms since the start of 2009. The effect is evident around the continent - Finland's GDP shrank an annual rate of 9.4% in the second quarter of this year; Germany's export-dependent economy is likely to decline by 5% this year, twice as much as the U.S.; and lacking any impetus from export growth, Spain's unemployment rate could top 20% in early 2010. For the entire eurozone, the unemployment rate is expected to breach 10% in the near term, a prospect that has alarmed European policy makers. All too mindful of the fragility of the eurozone's recovery, Jean-Cluade Trichet, president of the European Central Bank (ECB), has become increasingly vocal about the dollar's slide. In mid-October, for instance, Mr. Trichet said the US commitment to a strong dollar policy was "extremely important." That's true - but more for Europe than the United States. The fact of the matter is that the U.S. needs a weak dollar to generate export-led growth and to re-orient its economy away from rampant personal consumption. With the U.S. consumer saving more and spending less, dollar weakness has never come at a better time to America, boosting exports and the foreign earnings of U.S. multinationals. Washington policy makers know this and are not about to fiddle with success. Hence, the "strong dollar" mantra of the Obama administration does not carry much weight. It has become a phrase with little currency. And besides, Mr. Trichet should direct more of his comments towards Asia, where various monetary authorities have intervened in the markets in recent weeks to bolster the dollar's strength against their own currencies.
Asian policymakers want to slow the pace of the dollar's decline in order to protect their export-dependent economies. In doing so, however, Asia is shifting the burden of the dollar's decline and the brunt of global rebalancing on to Europe. In other words, most of Asia is comfortable with a weaker dollar as long as the decline does not come at their expense. If the dollar is going to slide, let Europe bear the pain. As The Economist recently noted, most of Asia's currencies have fallen since 2008 and are among the most undervalued in the world right now. With the yuan basically repegged to the U.S dollar, the slide in the dollar has coincided with a decline in the trade weighted value of the yuan, making Chinese exports cheaper and imports more expense. The upshot - rising Chinese exports to Europe, which has triggered European antidumping investigations. In the end, Europe's effort to talk up the U.S. dollar is likely to fail. Washington is relatively comfortable with a weak currency at this juncture, while Asia is not about to abandon its export-led growth model. That suggests a stronger euro over the near-term and more pressure on corporate Europe's ability to compete globally. Looking ahead, Europe has a great deal riding on the greenback. Further dollar weakness could ultimately force Europe policy makers to cut interest rates and opt for more fiscal measures.
Both options are anathema to the ECB and many European governments already deep in debt. They may, however, have no other choice since the U.S. dollar is our currency, but Europe's problem.
The views expressed in GMF publications and commentary are the views of the author alone.