Ripping Defeat From The Jaws Of Victory

WSJ.com – Euro Vision
Europe should be celebrating. Some internal difficulties aside — their economies aren’t sufficiently integrated and the single currency is causing some discomfort — the euro is a smashing success. Yes, a strong euro will make European exports more expensive. It also shows that other central banks and investors are willing to buy the euro in lieu of dollars. The euro has hit the big time.

Another side benefit, though it might be painful, is that it could force some additional liberalization of European economies. To adjust to the more expensive euro, labor markets should be liberalized so labor can be reallocated. This will benefit the Europeans in the long term.

The year 2003 was fabulous for Europe’s fledgling currency, the euro. Against the dollar, the euro advanced some 19% from the first to the last day of the year. And as 2004’s trading year starts in earnest, it looks like more of the same.

One would think European Central Bank officials would be dancing in the streets because of the euro’s obvious success. But on the contrary — there is much nervous fretting and fussing in Frankfurt that the currency is too high, that its ascent has been too fast, that something might have to be done about the strong currency, and other such nonsense. In today’s Europe, it seems, nothing fails like success.

There are, in fact, two reasons why the euro is appreciating. The first is the combination of relatively strong U.S. economic growth and Alan Greenspan’s refusal to raise interest rates. The stronger the U.S. economy, the bigger the external deficit — and the greater the need for higher interest rates to attract sufficient capital inflow into the U.S. to finance the deficit. Without the rate hike, the dollar goes down because the capital inflow will not be sufficient to finance the trade imbalance.

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ECB officials whispering to consultants and gossips that they would like to intervene or some such nonsense to slow the euro down are making a big mistake — and are fooling no one. The euro’s moves are based on fundamentals, not speculative excess. It is being led by central banks, especially in Asia — not the hedge funds and other speculators. This makes a huge difference. Even in the extremely unlikely circumstance that there would be joint intervention with the U.S., this would only give the Chinese central bank a better price at which to buy euros — and buy they would. The euro would bounce back in no time, and ECB officials and the Fed would look foolish. What a way to squander hard-earned credibility.

Instead, ECB officials should sit back, enjoy the ride and let the euro do its own thing in the foreign exchanges. They don’t have to become “euro braggarts,” but they have every right to enjoy the fruits of their labors in giving Europe the type of stability-based monetary policy it needs. If anything, the euro’s powerful rally proves the ECB critics wrong.

It’s good to hear a success story out of Europe. Economics is not a zero-sum game and Europe doesn’t prosper at the expense of the United States. On the contrary, we need a strong Europe and Japan to act as a balance when we go into recession. Having a single country driving the world’s economy does no-one any good.

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