Thu, 27 Apr 2000

Euro risks its reputation as value hits another low

By Andreas Oldag

BRUSSELS (DPA): Both the Brussels-based European Union Commission and the European Central Bank (ECB) in Frankfurt keep repeating their forecasts on the euro in a rosary-like litany -- the single European currency boasts enormous upward potential against the U.S. dollar, they both say in unison.

So far, the foreign exchange markets have not rewarded their optimism in the slightest. The euro has shed more than 20 percent of its external value since its launch on Jan. 1, 1999. Currently, it is posting new lows almost daily, and bankers and currency traders expect no recovery in the near future.

The exchange rate to the dollar -- the external value -- is not the sole yardstick for the stability of the fledgling currency unit, of course.

One can even draw the conclusion that the currency markets are ignoring reality, in view of the good prospects for the euro zone with economic growth seen at 3.4 percent this year. Paradoxically the stronger the European economy appears, the more the euro stumbles.

The ECB undoubtedly has succeeded in keeping the internal value of the euro stable so far. In Germany, at least, consumers have no cause to worry at present because inflation is moderate. And, for the European export sector, each cent that the euro softens against the dollar is like a small dose of economic upswing.

Airbus planes, European cars and other products can be bought cheaply in the United States.

Are the laments of the eurocritics unjustified? Are party politics the real issue behind all the doomsaying? For Germany's opposition Christian Democrats, the cause for the euro's weak performance is a foregone conclusion: the allegedly wrong financial and economic policy of the Social Democrat-led governments in Europe.

A closer look shows plenty of weaknesses in this argument, however. The average deficit in the national budgets of the Euro- 11 states fell last year to 1.5 percent of gross domestic product and most of them plan to reduce this figure to 0.5 percent by 2002/2003.

Nevertheless, the euro weakness is not exactly a reason to rejoice and an objective assessment of the risks is called for because the dangers of inflation have not been eliminated by a far shot.

Experience has shown that two to three years pass before all of the negative consequences of a currency weakness make themselves noticeable in a national economy. The acceptable inflation rate of "not over 2 percent" that the ECB has set could be exceeded soon because of the higher import prices.

The signs in Italy, Spain, and Ireland are alarming already. The Irish government reported an inflation rate of 4.6 percent for February. Italy overstepped the 2.4 percent mark and Spain's figure was even higher at 3 percent.

No wonder that the ECB has begun cautiously hiking interest rates to fight that trend. ECB President Wim Duisenberg does not see the risks of imported inflation as slight by any means.

A further danger is that EU politicians pay too close attention to export growth and thus fulfill the negative expectations of the foreign exchange markets: The more political leaders talk about the blessings of the euro weakness for the export sector, the harder a revaluation of the euro becomes. Insofar, the currency markets are not even reacting illogically in not trusting the alleged upward potential of the single European currency.

The performance of the U.S. economy in particular has shown in the past years that a strong dollar does not strangle the domestic economy by any means.

On the contrary, the radiating strength of the U.S. dollar is attracting investors. The high capital requirement of the U.S. economy therefore can be covered by this means. It is a misunderstanding anyway to believe that large economic areas such as the European Union or the United States are driven mainly by exports. The economic dynamism of the domestic markets play a decisive role.

Every devaluation carries a risk of spawning fears of further of devaluation. That could lead to dangerous outflows of capital that could be stopped only by further interest rate increases. To help avoid that, EU politicians should take great care not to play down the dangers of a continuous euro weakness.

The young European currency needs to be nurtured with care. This includes particularly an economic and financial policy that is very open towards reforms. The aim has to be to break down encrusted structures on the labor markets and to reduce budget deficits even further.