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SPEAKING FREELY
The cloud over the euro
By David Champeau
Speaking Freely is an Asia Times Online feature that allows guest writers to have
their say.
Please click here if you are interested in contributing.
On January 4, 1999 the world witnessed the birth of the euro currency. Eleven
European countries fixed their currencies to the euro. The world's financial
systems were all upgraded to begin electronic trading of the single currency.
Wim Duisenberg, a Dutchman, was the head of the European Central Bank (ECB).
European politicians like Gerhard Schroeder, once very critical of the euro
idea, changed their stripes and sang praises for the smooth introduction. Hope
sprang eternal for Europe, which believed it now had a currency to rival the US
dollar.
But as is usually the case, an unforeseen event changed the initial euphoria:
the NASDAQ bubble. In one of the greatest spectacles of market mania ever
witnessed, on the day the euro began its electronic trading the NASDAQ opened
up at 2,178.21. Over the next 14 months, the soaring NASDAQ would steal not
only all the headlines, but also most of the speculative capital of the world
as it rose to a high of 5,048 in March 2000. The NASDAQ mania dragged the US
dollar along for the ride, and in the process drove the euro/dollar exchange
rate from the opening 1.18 down to a low of 82 cents.
At the height of the NASDAQ mania, we heard Larry Kudlow on CNBC use the phrase
"king dollar". The US dollar was indeed "king", but it would prove to be an
emperor with no clothes. In Europe, Wim Duisenberg was forced to withstand the
insults coming from the press, which included the epithet "Dim Wim", supposedly
given to him for his changing opinions on monetary policy. It is amazing what
bull and bear markets can do: the transient market situation in 2000, in the
eyes of the world, had made the Americans into dynamic geniuses and the
Europeans into idiots.
While pundits were scratching their heads about the weakness in the euro in
2000-2001, something else was happening. The central bankers of the
industrialized world had been raising interest rates into 2000. The US Fed
Funds rate hit 6% while ECB short rates went up to 4.75%. Then the NASDAQ ran
out of gas, and the central bankers turned around and started cutting rates. In
2001, Alan Greenspan could not cut rates fast enough and by the end of 2001,
Fed Funds rates were at 1.75% while ECB rates went down to 3.25%.
It was during this period, particularly during April and May 2001, that Fed
Funds rate moved below the ECB short rate. The US Dollar Index [1] was making a
massive double top at 121 while the euro/dollar cross rate was plumbing a large
bottom of between 82 and 95 cents. On January 1, 2002, the ECB introduced the
official notes and coins that replaced the national currencies. Thus the euro
became a real currency. The exchange rate with the US dollar was still about 90
cents but the bottom was being completed. As 2002 unfolded, the euro began to
move higher and the US Dollar Index began to move lower.
By the beginning of 2003, the euro/dollar exchange rate was above parity and
moving higher quickly. The catch phrase in the media had changed from "Dim Wim"
to "dollar benign neglect". The US government was still spouting the "strong
dollar" policy without ever defining what that meant. Pundits accused the
administration of wanting a lower dollar. The central banks were still lowering
interest rates occasionally and by the end of 2003 the Fed Funds rate stood at
1% and the ECB short rate stood at 2%. Jean-Claude Trichet was now the head of
the ECB and the euro/dollar exchange rate had returned to where it started in
the 118 range, even exceeding 118 in May 2003.
At the end of 2003, the catch phrase in the media had changed from "dollar
benign neglect" to "twin deficits." The Bush administration and the US Congress
were spending like drunken sailors and the US trade deficit was skyrocketing
into the stratosphere with billions of dollars being shipped to China every
month. The whole world was wondering how much the US could spend and whether
all this spending and debt accumulation was good for the global economy, or
would end in ruin. At the end of 2003, the euro/dollar exchange rate stood at
1.25 and was poised to move higher.
At this point, the global economy was recovering, led by commodities. China was
buying everything in sight and a huge bull market in commodities was on. The
price of crude oil in US dollars was shooting higher trying to break through
the $40-barrel level. In euro terms, the price was moving sideways as the rise
in the currency offset the price rise in US dollars. It was a weak dollar
story.
As 2004 moved along, the Federal Reserve began to raise interest rates. At the
end of 2004 the Fed Funds rate stood at 2.25% while the ECB rate was still at
2%. The euro/dollar exchange rate hit a high of 136 in December 2004. The media
was talking about the euro as a "great success" and was signing the death
certificate of the US dollar. The big question in the euro zone was "how strong
is too strong?" The big question in the US was "will the dollar survive?"
Thus far in 2005, the Federal Reserve has continued to raise interest rates,
and at the end of June the Fed Funds rate will be at 3.25%, while the ECB is
still "on hold" at 2%. The US dollar looks like it has made a bottom and is
currently showing strength against the euro. Success does funny things. As the
global economy has been recovering, the euro zone economy has been lagging the
US economy. Growth is a low 1% or so in the euro zone and the politicians are
screaming at the ECB to cut rates even further, while ignoring the fact that
Germany has had two straight years of record exports in the face of a strong
euro. The ECB is standing its ground, telling the national parliaments to enact
market reforms so that the European market can become "dynamic" like the US.
Meanwhile, the money supply in the euro zone is growing at a healthy 8-9% a
year. This appears to be a classic example of a central bank that can control
one thing (interest rates), but not two things (interest rates and money supply
growth).
In March of 2005, the European Commission relaxed the "standards" of the
much-heralded Growth and Stability Pact, effectively ending any semblance of
fiscal discipline in the euro zone. The euro promptly sold off on the forex
markets. Jean-Claude Trichet, the benefactor of the Euro strength for two
years, is now under extreme pressure to "do something" to promote growth in the
euro zone.
Now, in June 2005, we have the French and Dutch voting "no" to a EU
Constitution. European politicians are in disarray. They want the ECB to bail
them out. Germany is at a standstill as the majority of the population fear
they could lose their jobs. There are calls from Italy to bring back the lira
in a duel currency system. Tony Blair's government in England has called off
the referendum on the EU Constitution. The EU Constitution looks dead. The EU
project has hit a wall for now and the euro seems to be showing signs of a
currency in trouble.
Overall, the euro has followed a mercurial path. With the effective end of the
Growth and Stability Pact and the EU Constitution, we will see just what the
euro is really made of. It has gone through one complete cycle, from
introduction to bear market to bull market and global acceptance. This is a big
boys' game, and the currency market can be a cruel place. With the current 8-9%
growth of the money supply, 1% economic growth and 2% interest rates, compared
to the US dollar's 4% money supply growth, 3-4% economic growth and 3%+
interest rate, the euro is looking weak. The ECB talks hawkish and it seems
that it would like to raise rates and slow down the money supply growth. But
with the economies of the euro zone growing ever more slowly, the ECB's hands
are tied.
Maybe the "No" votes this month will be a wake up call for Europe. My German
friends believe that Schroeder will be voted out of office this fall. So does
the Economist magazine. Signor Berlusconi in Italy is also on the ropes after
his party Forza Italia lost big in regional elections earlier this year. Tony
Blair won for a third time in the UK but with a smaller majority and will do
nothing to rock the boat. In France, Jacques Chirac is running around Europe
trying to save what is left of the European project. Politicians all around
Europe are circling the wagons and pointing their guns at the ECB to "do
something". The pressure is mounting as the ECB's Trichet fends off talk about
the demise of the euro.
Booker T Washington once said, "I have learned that success is to be measured
not so much by the position that one has reached in life as by the obstacles
which he has overcome while trying to succeed." The Europeans have many
obstacles that they must hurdle in order for the euro to continue to be a
success story. Time will tell if they can do it.
[1] Just as the Dow Jones Industrial Average provides a general indication of
the value of the US stock market, the US Dollar Index (USDX) provides a general
indication of the international value of the US dollar. Similar in many
respects to the Federal Reserve Board's trade-weighted index, the USDX does
this by averaging the exchange rates between the US dollar and six major world
currencies.
David Champeau runs a
blog
(Copyright 2005 David Champeau.)
Speaking Freely is an Asia Times Online feature that allows guest writers to have
their say.
Please click here if you are interested in
contributing. |
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