Edward,
I’m sceptical of your big sudden Euro drop scenario because it implies that the Euro is undergoing an unwarranted appreciation, with a future sudden reversion to reality.

If in fact you compare against other currencies besides USD-Euro, the implication is a depreciation of the USD.

A depreciation seemingly warranted by the US Government’s fiscal deterioration.

The big drop scenario would be more plausible if the EU were undergoing its own fiscal deterioration, but I don’t see evidence of such, not on the scale of what’s happening in the U.S.

“seemingly warranted by the US Government’s fiscal deterioration.”

Actually, the drop in the dollar is more about a drive by the Fed to avoid deflation in my book. Although obviously there are various motivating factors, including the current account deficit.

Obviously, on opinions for the future: to each his own. But since I see the US as fundamentally healthier economically than Europe and Japan, I can’t buy the Yen/Euro rise which seems to be the logical corrolary of the dollar fall. My impression is that US economists understand what is happening much better than the European ones: with a few honourable exceptions of course (try reading the Economist’s Buttonwood).

I consider the european fiscal problem orders of magnitude bigger than the US one, the US has some remedy: reverse the tax cuts, and raise taxes. This ’remedy’ is amuch more difficult to swallow in an already highly taxed Europe. US demographics are much better too.

Then there is global labour arbitrage (see Stephen Roach). The US is having problems now precisely because they are getting to grips with this. Europe has yet to seriously confront the problem, but the point of my ’globalise or die’ thing is that it will come.

Ok, no-one has ownership to the truth here. These are just opinions. Later this year we will be a bit clearer about which of these scenarios is nearer to the reality.

It doesn’t seem so long ago that David was complaining about too many Iraq and Howard Dean posts (oh Howard, wherefore art thou? How time flies). Now I fear he will be on at me about too many euro ones. In an effort to keep this under control, maybe I should learn to use the quick links. Meantime an update for the comments section. From Bloomberg this morning:

“The euro strengthened for a second day in Asia after European finance ministers said they didn’t discuss currency sales as a way to stem a rally that is eroding demand for the region’s exports.

Finance ministers meeting in Brussels yesterday said they were banking on the Group of Seven’s condemnation of “excess volatility” to tame the euro’s rise against the dollar. Selling the euro “is not an issue on the table,” Belgian Finance Minister Didier Reynders told reporters before the meeting.”

“European officials sounded pretty pleased with themselves and content with the level of the euro,” said Robert Rennie, currency strategist in Sydney at Westpac Banking Corp. “The market is going to keep pushing up the euro, testing just how long Europe remains happy with it.”

As of 2:54 p.m. in Tokyo, the euro rose to $1.2743 from $1.2700 late yesterday in New York, according to EBS prices. The European currency was also at 134.47 yen from 134.11. The euro may rise to $1.30 in the next few weeks, Rennie said.”

My feeling is $1.30 and then some. As I keep saying, this is largely US data driven, and especially by the problems in the ’soft’ labour market there. So only two questions: what value will be considered to be ’too high’, and when we reach that point, what will be the plan?

Hmmm… I’m not quite sure what to think, but I think that I ought to think something. I’m a bit more immediately affected by exchange rates than most folks, since I earn money in euros, in a business that is structurally protected from overseas competition, while I have debts in dollars. The strong euro/weak dollar is definitely to my immediate advantage, while a catastrophic shift against the euro is not.

One of the more practical bits of knowledge that my branch of linguistics teaches is to be critical of the metaphors that underlie discourse. This makes it damn dear impossible to read the business press because economic analysis is always couched in poorly rooted metaphors. That means I’m not quite sure what makes the US economy healthier than the European one. Europe certainly has labour available to hire and capital is, as you point out, pouring in due to the high euro. Undervaluing a currency is an effective way of creating exports, but running a trade surplus is, on the long run, effectively a transfer of capital to states with trade deficits.

The US also has a good deal of underutilised labour milling around, but if your account is accurate it’s facing capital flight. Under the Bush administration, American deficits as a percentage of GDP are certainly just as high as Europe’s and personal debt is vastly higher.

I suppose there is a simpler remedy available to the US - dispose of George W Bush - than Europe. But I’m not sure that’s enough to stem capital flight, deficits or high personal debt. Europe, on the other hand, seems well positioned to lower interest rates and I have the impression that that’s what everyone expects Trichet to do. If there is strong demand for European securities, then they don’t need nearly as high interest rates to keep capital in the market, right? Lower interest rates are certainly a very critical factor in business development, and lower interest payments on public debts free up state capital to spend or to reduce taxes. If France and Germany lose in the ECJ for breaking the stability pact - and then actually accept the judgment and cut spending or raise taxes - this certainly minimises the risk that European governments will take advantage of lower interest rates to run up new deficits. It seems to me that the remedies avaiable to Europe are at least as attainable as those available to the US.

My biggest frustration with economics is that the more I think I understand, the less it makes sense.

“My biggest frustration with economics is that the more I think I understand, the less it makes sense.”

Don’t worry Scott, you aren’t alone here.

More from Bloomberg. I am posting these updates because I entertain the vain hope that people may take note and remember who was saying what here:

“The euro climbed for a third day in four in New York as European Central Bank Chief Economist Otmar Issing and the region’s finance ministers suggested the bank won’t sell euros to stem a two-year rally.

Euro gains help slow inflation, and “there is no point in unleashing a short burst of fire,” Issing, one of the bank’s 18 policy makers, told the German newspaper Sueddeutsche Zeitung. European finance ministers meeting in Brussels said they won’t push the ECB to sell euros.

Finance officials “haven’t shown too much displeasure over the euro’s rise,” which has taken it 46 percent higher in the past two years, said Tim Mazanec, senior currency strategist at Investors Bank & Trust in Boston, which is custodian for $1.1 trillion in assets. “It’s just a matter of time before the euro makes new highs.”

“Traders bid up the euro as European finance ministers including Austria’s Karl-Heinz Grasser and Spain’s Rodrigo Rato said no action is needed beyond Saturday’s Group of Seven condemnation of “excess volatility” in exchange rates.”

““The effect of a further euro appreciation on growth would be just minor,” Grasser said on the second day of a meeting of European Union ministers in Brussels.”

““A strong and stable euro is good for Europe,” Spain’s Rato said as he arrived in Brussels.”

Of course I’m not saying there is much to be done. We are effectively pretty much impotent. But I wouldn’t be calling the weekend’s G7 satisfactory, nor would I be expressing satisfaction with what is happening.

I will tell you all what I really think when we get to see Germany’s end-of-year inflation (deflation??) and growth numbers.

With Regards to capital flight…
Hasn’t happened yet as far as I can see (stock valuations too high, interest rates too low), it’s only a risk so far.

It may not happen, ever. Or it could happen tomorrow (say GWB were to commit suicide and Cheney became President, or vice versa).

Gold bug checking in here, if only to give you guys someone to beat up on. Edward, you’re the only commentator I’ve run across who isn’t a gold bug who realized that having the de facto standard currency be a fiat currency is a big problem. My reasons would differ somewhat from yours, nevertheless, it’s pretty obviously a problem. Also of course I’d agree with your big drop scenario, ’cause us guys are certain that all the paper currencies are going to go up in smoke sooner or later anyway.
But back to Earth: to me it seems that the WTO should make massive interventions like those of the BOJ illegal. Basically, if you’re a member of the WTO you shouldn’t be allowed to do what they’re doing.
Also, I’m a bit confused, or maybe just misinformed re the Eurozone’s reaction to all this. I got the distinct impression that the European authorities had decided that the Japanese had proven that intervention does work to some extent, and were not averse to trying some on their own. Was I just plain wrong?

Gold is a has-been fiat currency.

Hi Paul,

No I’m not a gold buff I’m afraid. I was brought up on the debate about the gold standard and its problems. I have no ’handy in my pocket solution’, but I do think we should be looking urgently at this issue.

The proposal Paul Davidson gave to the G23 finance ministers in 1999 would be a good starting point. Summary here:

http://www.livingontheplanet.com/bl/archives/000040.html

Davidson told me that in January 1999 everyone was all ears, and by March it had all been forgotten. The topic I think will come back.

On the update front, today all eyes are on Alan Greenspan. But again the words are going to be a ’famous for 15 minutes’ type phenomenon.

Fiscal topics are important Scott and Patrick, but I think what Roach calls the global labour arbitrage is the key factor here. See this post and comments if you are interested:

http://www.livingontheplanet.com/bl/archives/000203.html

and this one plus comments:

http://www.livingontheplanet.com/bl/archives/000155.html

As long as the US doesn’t stabilise this situation, deflationary pressures will prevail, and the dollar will continue to fall. How then does anyone put a ceiling on the euro? Good question. The Japanese - as Paul indicates - are printing plenty of money, but to little effect. The ECB can do likewise, although I think there are problems in the regulations here, especially if you think inflation and not deflation is the problem.

OTOH, Bernanke is committed to unconventional measures if needed, among these would be printing money to buy non dollar assets - eg Euro or Yen denominated government debt. So we could have a buying/selling war, depending on how you look at it.

Quotes of the day from Bloomberg:

“The euro rose in London after European finance ministers yesterday said they wouldn’t push their central bank to sell the currency, which gained 18 percent against the dollar in the past year.

As of 6:38 a.m. in London, the euro climbed to $1.2702 from $1.2672 late yesterday in New York, according to EBS prices. It gained to 133.99 yen from 133.79.

“The prospect of intervention only becomes likely if the euro pushed up above $1.40,” Claudio Piron, currency strategist in Singapore at Standard Chartered Plc, said in a television interview with Bloomberg News. “The ECB’s policy is very conservative.” Standard Chartered forecasts the euro will rise to $1.40 by June.”

“The European currency’s gain last year cost Renault SA, France’s second-largest carmaker, 311 million euros ($395 million) in operating profit, Chief Financial Officer Thierry Moulonguet said yesterday.”

“For Royal Philips Electronics NV, Europe’s largest consumer- electronics maker, a 10 percent drop in the dollar cuts Philips’s operating profit by 3 percent to 3.5 percent, Chief Financial Officer Jan Hommen said at a press meeting yesterday in Amsterdam.

About 50 percent of the company’s sales and as much as 80 percent of its financial expenses are in dollars or “dollar- related” currencies, Hommen said. “

A U.S. jobs report on Friday lowered expectations the Fed will raise interest rates soon, and any indication from Greenspan reinforcing that view will send the dollar lower, said analysts including State Street’s Kalirai.

“I expect him to stress what ‘patient’ means, and what that means is rates aren’t going up anytime soon,” Kalirai said. “The trend is going to continue for the dollar to go down as assets flow into higher-yielding areas.”

The failure by the G-7 to make explicit mention of the dollar’s decline may extend its slide, German government economic adviser Peter Bofinger said yesterday.

“It’s a shining example of indecision,” said Bofinger, who will join Chancellor Gerhard Schroeder’s panel of economic advisers, known as the Five Wise Men, on March 1, in a televised interview with Bloomberg News in Berlin. “I wouldn’t be surprised if the dollar’s drop continues.”

Interesting article by Davidson. Amusingly - or maybe not - we seem to be seeing #6 subsection 3 in action, with Japan spending massive sums to buy up US debt and thereby in effect engaging in a massive aid program for the US. Wolf makes this point in his column in today’s FT. (Yesterday’s, by the time you read this comment I’m sure.)