Posted on 07/11/2007 11:04:36 PM PDT by bruinbirdman
Yesterday, the pound and the euro hit their highest levels in a generation against the US dollar. The dollar, meanwhile, collapsed to a record low against an average of all the world’s major currencies. It is tempting to interpret the flight from the dollar in financial markets as the clearest, most objective, indicator of America’s relative decline.
Europe has long been derided as an ageing, sclerotic continent, doomed to irrelevance in a world dominated by America and Asia. But could it actually be America, not Europe, that is failing to compete in the globalised world economy and is now threatened with long-term decline?
Much that is happening in the world today certainly seems to belie the hubristic assumptions about American hegemony that were so prevalent a few years ago. It is not just the military debacle in Iraq and the geopolitical setbacks suffered by American diplomacy from the Middle East to Venezuela to North Korea. Less prominent in the media headlines, but in some ways more troubling, are the indicators of economic underperformance: the reliance on foreign borrowing (now equivalent to $2,000 annually for every American man, woman and child); the loss of Wall Street’s global dominance in financial services to the City of London; and now to cap it all, the dollar collapsing to record lows. Surely this is the ultimate vote of no confidence in the US economy by people who are best placed to know?
Sadly, for those of us who live in Britain and Europe and would like to believe that the strength of our currencies reflects our superlative economic prospects, the answer is an emphatic “no”. There was a time in the 19th century when the strength of sterling reflected Britain’s unparalleled prosperity and imperial power. But since the deregulation of currencies and financial markets in the 1980s and 1990s, currency strength has conveyed almost no information about the health of a national economy – and none at all about a country’s competitive position in global trade. For example, anyone who believes that the falling dollar reflects America’s huge trade deficit and foreign borrowing should consider that the one leading currency even weaker in the past three years than the dollar has been the yen; yet Japan has the world’s biggest trade surplus and is the greatest creditor nation the world has ever seen.
To the extent that any relationship has existed between currencies and economic performance, it has usually been the “wrong” way round – rising currencies usually preceded periods of economic decline, while weakening currencies have presaged economic strength. Think, for example, of the collapse of sterling in 1992, which ushered in the strongest and longest period of economic expansion in British history.
Or consider the strength of the US economy in the late 1990s, just after the dollar fell to its previous nadir in 1995. Even more spectacular has been the decade of growth in China since its currency collapsed to a record low in the Asian crisis of 1997. On the other side of the ledger, there has been Japan’s stagnation after 1995, when the yen hit a record high, and Germany’s lost decade after the surge in the mark that followed German reunification and the eurozone’s dismal economic performance from 2003 to 2005, as the newly created euro appreciated by 60 per cent against the dollar.
There are many explanations for the apparently perverse relationship between currencies and economic performance, though none of them is watertight. For example, currencies tend to strengthen in response to rising interest rates and fears of inflation – which are obviously bad for economic performance – but also in response to strong economic growth.
On the other hand, a currency may weaken because inflation prospects are improving, as they are in the US at present, or because investors fear a financial collapse, which some believe to be a looming in the US mortgage market. But if the causes of currency strength are ambiguous and contradictory, the consequences are clear. A currency that keeps rising, as the euro and sterling are at present, will eventually do serious damage to almost any economy, hurting export competitiveness and stunting growth.
This is what happened to Britain and America after the pound and the dollar appreciated excessively in the early 1980s and again in the early 1990s. It happened to Germany and Japan in the mid1990s and again in the middle of this decade to the eurozone. Europe and Britain enjoyed some relief in 2005, when the euro and the pound temporarily weakened.
But now they will have to bear the full brunt of excessive currency strength. In Britain’s case, the strength of the pound may not do too much harm, since it will forestall or at least delay any further rate rises from the Bank of England. On the Continent, however, the European Central Bank seems determined to keep raising interest rates, thereby exacerbating the damage done by the euro’s excessive strength.
Americans, meanwhile, will enjoy the benefits of a super-cheap currency, which will more than offset falling property prices and problems with a small minority of mortgage loans. American politicians, for all their faults, instinctively understand this, which is why they have generally welcomed a falling dollar and have been pressuring China and Japan to let the dollar weaken against the yen and the renmimbi – not just, as at present, against the euro and the pound.
European policymakers, by contrast, seem to have no idea of how currency markets operate. In contrast with Americans and Asians, German politicians in particular still see a “hard currency” as a virility symbol – not as a threat to economic performance or an indicator that interest rates are probably too high.
There is only one leading European politician who seems to understand the dangers of an overstrong euro. This is Nicolas Sarkozy, who travelled to Brussels this week to plead for a more expansionary economic policy in Europe. But his pleas were met with ridicule from the other governments and the ECB. Within two months of promising to spark an economic revival, the new French President has already been paralysed by the rules of the eurozone.
That is the reality of life in today’s Europe – and one of the main reasons why America, despite all its problems, will continue to dominate the world economy in the decades ahead.
Oh, let's see. Boeing jets, Caterpillar bulldozers and cranes, oil refining equipment, nuclear powerplants -- to name a few.
They don’t have any of those in the stores I go to. ;-)
Inflation, as Friedman said, is everywhere and always a monetary phenomenon. Never mind the nonsense about the ''core rate'' of inflation, the fact that inflation is both present and nearly rampant in today's economy is demonstrable just by inspecting a list of comparative prives (or, ftm, looking at a series of commodity prices charts.)
This is very solid proof that the printing presses are running overtime. The level of monetised debt, too, is the highest in history.
Perhaps those prices don't necessarily reflect productive efficiency/worker but rather production/non-worker costs.
yitbos
Other considerations aside, the price differences reflesct the strong Euro.
Boy, the puny American stock market, denominated in puny Americans dollars did OK for puny me today.
yitbos
Ah—that all makes sense after you explained it. And thanks for the reply.
- The reasons to this are actually very simple:
It is more or less unavoidable for the currency of the world’s largest economy, The EU, to become a ‘global currency’, especially as The EU is a very open economy which both imports and exports a lot of goods and services.
Before the Euro, the only true ‘global currency’ was the dollar. Today, a lot of global trade is done in Euros, therefore THE DEMAND for dollars is not as big as it was before the introduction of the Euro. This is actually a matter of basic supply and demand economics.
Furthermore, the economic growth of continental Europe is presently better than it has been for over 15 years, 3.3% on an annual basis. This is very low compared to India and China (in fact even to some European countries, like Finland which recently enjoyed a GDP growth level of nearly 7%), but it is decent. Simultaneously as the Euro has established itself as a true ‘global currency’ and financial experts around the world have become more and more convinced the Euro project will NOT collapse in quarrels and internal strife among the Euro countries, the US has entered a period of more modest economic development than it has enjoyed for a long stretch of years recently.
But is the strength of the Euro a problem for the US (and/or for The EU) in the long run?
Hardly. For too long, The US has exported dollars and imported products of other countries. Indeed, the US have also managed to sell a lot of high quality products to the rest of the world, but The US is less dependent and less successful in terms of exports compared to several Asian and European countries.
Today, the dynamic US economy is facing a major opportunity; the conquest of the lucrative, growing export markets of Asia and Europe. Many American companies are already highly active in this area, but due to the comparatively cheap dollar, the ground is prepared for even greater success.
My advice to the Americans, who are admired around the globe for their spirit of competitiveness among people who know something about economy:
- Go for it!
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