May 20, 2003
Euro Comes Alive as a Shock Absorber for World Currencies
RANKFURT, May 19 Two days after John W. Snow, the United States Treasury secretary, rewrote the script for currency traders around the world with a few well chosen words about the dollar, the euro showed today how thoroughly it has taken on its latest role: shock absorber for the world's leading currency.
On its first day of trading since Mr. Snow's remarks, the euro traded as high as $1.1737, before settling back to $1.1643 in New York. It has been a remarkable rebound for a currency that began life in 1999 at a rate of $1.168, before slipping into a long, politically embarrassing decline.
Even more remarkable is how little this recovery had to do with the euro itself. The currency's resurgence is less a reflection of Europe's strength than of a perceived weakness in the United States.
The euro has also been favored by investors because of the economic troubles in Japan, and the resolve of Japanese and other Asian banks to defend their currency from strengthening too much against the dollar.
"We have plenty of our own bad economic news," said Michael Schubert, a currency analyst with Commerzbank in Frankfurt. "But you have to compare it to the problems in the U.S. and Japan. The problem we have is that the euro has become the one-eyed man among the blind."
Today's jump was set off by Mr. Snow's comment that the recent decline in the dollar "really is a fairly modest realignment of currencies." Speaking after a meeting of finance ministers of the leading industrial countries in France, he listed several attributes of a strong dollar. The exchange rate was not one of them.
Analysts here spent the day parsing Mr. Snow's meaning, some noting that one of his aides scrambled to assure reporters afterward that the official Washington policy of a strong dollar had not changed.
But the verdict in the currency markets was immediate and unambiguous: the euro sprang upward, as investors from Sydney to Tokyo to London dumped dollars and bought euros by the billions.
"I am optimistic that Mr. Snow was simply saying what he thought about the dollar," Mr. Schubert of Commerzbank said. `But sometimes, silence is golden."
The danger, Mr. Schubert said, is that the market will overreact to Mr. Snow's remarks, driving the euro above $1.25. Some analysts warn that if the dollar enters a long-term downturn, as it did from 1985 to 1995, the euro could trade as high as $1.40 by next year.
Such projections have fanned fears in Germany, France and other countries that a strong euro will hobble exports, one of the few cylinders still sparking in their sputtering economies. Stock markets tumbled by more than 4 percent in Frankfurt, Paris and Amsterdam as investors reacted to Mr. Snow's comments.
Some people in the markets even spied a political motive, saying a weak dollar could be used by the White House as retribution against Germany and France for their opposition to the war in Iraq.
Most analysts here, however, dismissed that as a conspiracy theory. They said Europeans had to come to grips with the fact that American policy toward the dollar was driven by a single goal: to help the American economy. At times, that may clash with the interests of Europe.
"We have had no change in U.S. policy toward its exchange rate," said Norbert Walter, the chief economist at Deutsche Bank. "The policy has always been `the dollar is our currency and your problem.' "
At a time of burgeoning domestic demand and productivity gains in the United States, Mr. Walter said, a strong dollar made sense. Now, with domestic consumption weak and the risk of inflation minimal, a cheaper currency could fuel growth by making American exports cheaper.
"We should not think of what the U.S. wants to do, good or bad, to other countries," Mr. Walter said. "`We should think, `what is in their interest?' and then figure out the right remedy."
The obvious remedy, he said, is for the European Central Bank to cut interest rates. The bank has resisted such a step for months, because it remains intent on curbing inflation.
It has become clear, however, that rising prices are not a risk in Europe. The bigger danger, at least in Germany, is from falling prices, or deflation. The International Monetary Fund said in a report that Germany faced a considerable risk of deflation because of near-zero growth, soaring unemployment, and limited scope for fiscal or monetary policy.
The report noted that Germany's situation had been aggravated by the rise of the euro, and the European bank's strict policies, which are devised to suit all 12 countries in the monetary union.
The German chancellor, Gerhard Schröder, denied his country was in danger of deflation. But other officials, including Finance Minister Hans Eichel, have been applying pressure for a cut in rates.
What frustrates people here, aside from the bad timing of a weak dollar, is that the euro has been more affected than other major currencies. The euro rose 27.6 percent against the dollar in the last year, while the Japanese yen rose 8.4 percent, and other Asian currencies even less.
Part of this is because the Japanese central bank has intervened in the market to prevent the yen from strengthening too much. Asian countries that export to the United States have piled up huge dollar reserves to prevent their currencies from rising too much against the dollar.
They, too, worry that strong currencies could hurt their exports. And they fear losing their competitive edge to China, which has a booming, low-cost industrial sector and a currency that is pegged to the dollar.
"For the Asians, it is great," said Marc Faber, a money manager in Hong Kong. "They can have huge increases in exports to Europe."
Europeans note, with some chagrin, that their economies are hardly world-beaters. But compared with Japan, which is in a decade-long downturn that shows no sign of ending, or the United States, with its corporate scandals and yawning current-account deficit, Europe looks safe and reliable.