Dollar war: Is Europe the patsy?This article marks Floyd Norris's debut as a columnist for the IHT. He will examine international financial and economic issues in this space on Friday's.
What happens if the world won't let the dollar fall?
That question may sound odd given the run of headlines about the plunging dollar, but the reality is that the dollar is still strong where it counts.
And that is bad news for Europe.
Since the end of 2001, the dollar is down 30 percent against the euro. But against a basket of currencies - weighted by how much each country contributes to the American trade deficit - it is down just 6.7 percent.
The reason is that not all countries play by the same rules. Only a few are willing to allow their currencies to trade freely. China, which has the largest trade surplus, $123 billion in the latest 12 months reported, fixes its currency's value against the dollar. It has turned away U.S. suggestions that it change that policy.
Japan, which ranks No.2 with a trade surplus of $68 billion, bought around $200 billion last year, which presumably slowed the yen's rise. The dollar is down 19 percent against the yen since the end of 2001.
The rise of the euro at first brought some joy to Europeans, who had been embarrassed by their new currency's earlier slide. But now there is growing concern among companies and politicians that the euro will rise far enough to damage the nascent European recovery.
A cut in European interest rates might discourage capital from coming to Europe, and thus reduce the value of the euro or at least slow its ascent. It also might lift economic confidence in Europe, which has begun to sink again.
But the European Central Bank on Thursday left rates unchanged, with Jean-Claude Trichet, its chairman, appearing to be more worried about European budget deficits than about the impact of the rising euro. "Although recent exchange rate developments are likely to have some dampening effect on exports," he said, exports should continue to grow as the economy recovers.
The euro slipped before the ECB met, amid suggestions that Trichet might say something significant even if the bank did nothing. But he did not, and the euro rose again.
In America, the Federal Reserve seems to even like the fact that China won't let its currency appreciate.
"Looking at movements of the dollar against a single currency can be misleading about overall trends," said Ben Bernacke, a Fed governor, in a speech this week. "Broader measures of dollar strength show somewhat less of a decline." The way he sees it, that makes American inflation less likely, and therefore gives the Fed less reason to be concerned.
For the dollar to hold steady, foreigners must be willing to buy enough American assets - stocks, bonds, companies, real estate or whatever - to offset the current account deficit. If they don't buy enough, then the dollar must fall.
In theory, a declining dollar would lead to higher import prices that would reduce demand and bring down the trade deficit. But the current reality is that with the dollar not being allowed to fall against the Chinese yuan, economic adjustment will require a bigger decline against other currencies, primarily the euro.
The question now is whether Europe will stand by and watch its own competitiveness erode. Notwithstanding the Bush administration's empty "strong dollar" rhetoric, there appears to be little likelihood of Washington joining in a move to sell euros.
The ball is in the ECB's court. Its inaction is regrettable.