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May 25, 2003

For the Euro, the Worst Time for the Best of Times


FRANKFURT — It is a measure of the hard feelings on both sides of the Atlantic that when John W. Snow, the United States treasury secretary, signaled last weekend that the Bush administration would tolerate a weaker dollar, people here muttered darkly that the White House had finally found a way to stick it to France and Germany for having opposed the war in Iraq.

A falling dollar translates directly into a rising euro, which makes German-built cars and French wine more expensive in the United States. Just as a weak dollar could help revive the American economy, a surging euro could hobble the exports Europe needs for growth.

Few Europeans genuinely believe that American policy is motivated by revenge rather than self-interest. But the conspiracy theories lay bare a deeper frustration: Europe, already bruised by Washington's unbridled use of military power, now feels elbowed by its economic muscle-flexing as well.

The euro was supposed to right the economic imbalance. By uniting 300 million Europeans under a common currency, with a single monetary policy and tightly coordinated fiscal policies, the architects of the new Europe believed they could create a counterweight to American economic might — a stable, thriving bloc stretching from Dublin to Athens.

It has taken just three years of wobbly economic growth, and a shift in American dollar policy, to call that into question. "This is an unprecedented experiment," said Niall C. Ferguson, an expert on economic history and a senior research fellow at Oxford. "I don't think it can be proclaimed a success yet, and indeed I would argue it has been a slow failure."

To a currency trader or an American tourist visiting Europe this summer, such a verdict might seem bizarre. The euro, after all, is trading at the highest levels since it was introduced in 1999. It has recouped all the value it lost against the dollar in the last four years, and then some. The euro is becoming a preferred asset for international investors, who are unnerved by the yawning deficits in the United States.

The trouble is, "euro power" is coming at exactly the wrong moment in Europe's economic fortunes. Germany, Italy and the Netherlands are on the brink of recession; it would be their second in two years. A hard blow to exports could be enough to tip these countries into the trough.

In this regard, Europe and the United States are in similar straits. The difference is that Washington is tackling its problems with ruthless pragmatism, typified by its decision to soft-pedal the strong-dollar mantra that was first articulated in the mid-1990's.

Europe's central bank, by contrast, is wedded to core principles that go back considerably further than the Clinton administration. Derived from Germany's Bundesbank, they reflect its obsession with inflation, rooted in the hyperinflation of the Weimar Republic.

The quickest way to slow the rise of the euro would be to lower interest rates, something the Federal Reserve has done time and again in the United States. The European Central Bank, however, has held the line, saying the need to curb inflation still outweighs the benefits of lubricating the economy.

"American policy makers are not dogmatic," said David Mackie, the chief European economist at J. P. Morgan Chase. "They buy into ideas for a season, and they discard them when it is time to move on. European policy makers are far more stuck on dogma, through thick and thin."

To be fair, the European central bankers are expected to lower rates in June at their next meeting. The question is whether the remedy will be too little, too late for European industry. Volkswagen and DaimlerChrysler have already reported eroding profits; while both have other problems, and operate huge assembly plants in the United States, they say the euro is partly to blame.

The debate over interest rates is just part of a broader debate over whether the European monetary union is too rule-bound. The union's fiscal restraints are set out in its Stability and Growth Pact, which requires its 12 members to keep budget deficits to less than 3 percent of total output.

Germany, France, Italy and Portugal have all breached that ceiling. Given the restorative effects of government spending on a sickly economy, many economists say they were right to do it. For Germany, however, thumbing its nose does not come naturally. Chancellor Gerhard Schröder has pledged to push the deficit, now 3.8 percent of gross domestic product, back under the cap with tax increases and spending cuts.

Once again, the timing could not be worse. With zero growth, anemic consumer demand and historically low business confidence, the German economy, Europe's largest, needs a bracing tonic, not a dose of castor oil.

The White House, meanwhile, is pushing the federal budget deficit well above Europe's 3 percent mark, with a $350 billion program of tax cuts and state aid that the administration insists will revive the economy.

Not all of Europe's problems are rooted in the dogmatism of Brussels. Broader economic reforms in Germany and France have been hurt by a familiar mix of political backsliding, vested interests and the enduring appeal of social responsibility as a European ideal.

In France, public workers nearly shut down the country two weeks ago to protest efforts to rein in the pension system. In Germany, Chancellor Schröder is watering down his plans to relax entrenched labor laws in response to a rebellion by the unions and other leftist elements within his own Social Democratic Party.

Summarizing the state of affairs, the German weekly newsmagazine Der Spiegel said on its cover last week, "The Hour of Truth in a Land of Lies."

As Europe faces this hour of truth, some here believe the United States should be a model. Norbert Walter, Deutsche Bank's chief economist, said Europeans could start by drawing the right lesson from Mr. Snow's recent remarks. "The U.S. has always had the philosophy, `the dollar is our currency, and your problem,' " he said. "We have to come to grips with that."

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