When it comes to currency policy, silence is golden

By Knut Engelmann

WASHINGTON (Reuters): In the world of currency policy, silence is golden.

As Europe's top central banker revealed his latest thoughts on the euro to disastrous effect on Monday, the U.S. Treasury Department -- guardian of the long-standing strong dollar policy -- maintained a studied silence.

European Central Bank President Wim Duisenberg's comments in an interview that all but ruled out intervention to support the single currency if the Middle East crisis caused it to fall further, did more than just speed the euro's already dramatic decline. They also illustrated the vastly different attitudes to currency policy on the two sides of the Atlantic.

Europe's young currency has long suffered from the area's still-weak growth prospects -- but its pain has often been intensified by frequently conflicting signals from the continent's central bankers and politicians on where they want their hapless currency to go.

The euro is down some 27 percent against the dollar since it was launched with great fanfare at the start of last year.

Meanwhile the greenback, helped by the U.S. Treasury's consistent refusal to go beyond occasional restatements of its preference for a "strong dollar" and supported by the economy's robust performance, has outshined almost every major currency.

"When it comes to currency policy, you want to seem gray and dour and responsible," said Kevin Harris, economist at MCM Moneywatch in New York. "The Europeans are flighty."

Duisenberg told London's Times newspaper it would be inappropriate for the Group of Seven (G7) major industrial nations to step into markets and try to boost the euro when external events -- such as the current Middle East crisis -- contributed to extreme, rapid changes in currency values.

U.S. Treasury officials declined to comment on what many in Washington viewed as the latest in a string of inappropriate, if not downright silly, comments by euro-zone officials that have confused global markets and frustrated U.S. policymakers.

Financial markets took Duisenberg's remarks as a green light to sell the euro against the dollar, sending it down to levels not seen since the G7 intervened on Sept. 22 in an effort to halt its seemingly endless slide. The G7 contains Britain, Canada, France, Germany, Italy, Japan and the United States.

Analysts said that while Duisenberg's reasoning was sound, he was wrong to reveal it against the backdrop of jittery currency markets where traders hang on officials' every word.

"It would be a waste of their reserves to try and prop up the euro now as oil prices continue to shoot higher," said Jay Bryson, global economist at First Union Corp. "But if I were Mr. Duisenberg, I wouldn't be telling the markets right now."

Major industrial nations were estimated to have spent up to $6 billion last month in their bid to support the euro, so far without much success. But while currency traders remain wary of further intervention, many economists think the opportunity to do so again with any prospect of success has been lost.

"It's not just about the euro anymore," said Michael Rosenberg, head of foreign exchange research at Deutsche Bank Securities Inc. in New York. "The problem is the price of oil is rising, Middle East tensions are high, and sentiment for the dollar is still very positive."

Economists argue that rising oil prices are a much bigger problem for Europe's economy -- in the midst of a still-tentative recovery -- than they are for the booming U.S.

As the oil price puts a cloud on Europe's growth prospects and investors seek to shift their funds to where the economic outlook is best, the dollar is set to gain further, worsening the euro's prospects and rendering intervention useless.

Washington has long regarded currency intervention as a last resort, arguing it is doomed to fail unless backed up by real action such as structural reforms to boost growth or cut unemployment, clearly one of Europe's more pressing issues.

Last month, Treasury Secretary Lawrence Summers stressed he had authorized U.S. participation in the intervention only because of concern over financial markets skidding out of control and fears the weak euro could hurt global growth.

He insisted the move, designed to pull the euro back from the brink rather than to weaken the dollar, did not conflict with his repeatedly stated strong-dollar mantra. Other than that, he declined to comment -- reflecting Treasury's tight policy of never commenting on currency moves, intervention prospects, or anything else that may move financial markets.

"We're very consistent," said Harris of MCM Moneywatch. "We're so consistent that if we vary from our policy by trying to weaken our currency against somebody else's it doesn't call our policy into question in any significant way."

Of course the U.S. strong-dollar mantra, made famous by Summers' predecessor Robert Rubin, has come at a price.

Some U.S. manufacturers have complained the strong dollar hurts them as they receive fewer dollars when exchanging their foreign earnings back into dollars. And the greenback's attractiveness has boosted a trade deficit caused by the strong U.S. economy's appeal to foreign investors.

That puts the U.S. Treasury in an awkward position. The strong dollar will drive up the deficit further, raising the risk of a dramatic reversal in the future. But a substantially weaker dollar could hurt the economy even more by causing inflation, higher interest rates and falling investment.

The solution? Says Bryson: "At this point, saying nothing is certainly the best course of action."