[PEN-L:34241] the Euro

["Ian Murray" <seamus2001@xxxxxxxxx>]

Global Anxiety Propels Euro Above Dollar


By Robert J. McCartney
Washington Post Foreign Service
Friday, January 31, 2003; Page A01


PARIS -- Growing fear of war in Iraq has pushed Europe's common currency, the euro,
sharply higher against the dollar, reversing a long-established pattern in which
geopolitical jitters led investors to seek refuge in U.S. currency as a safe haven.

The euro has risen more than 20 percent since it was introduced a year ago in the form
of bills and coins as an emblem of a united continent. At the time it was worth only
89 cents. It was at parity with the dollar as recently as December and hit a
three-year high of more than $1.09 on Monday. The sharp gains in recent weeks have
consequences on both sides of the Atlantic for businesses, consumers and tourists.

Analysts say the euro is showing signs of becoming a serious rival to the
long-dominant dollar on world markets. Last week, the Russian central bank said it
would shift some of its foreign reserves from dollars to euros, to minimize losses
from holding the U.S. currency. China also has made a small shift toward the euro.

"We've seen a sea change with relation to the euro," said Jim McKay, senior strategist
at Cantor Fitzgerald in London. The markets "are really very nervous" about the
dollar, he said.

McKay and other market experts said international investors are worried that the
United States and Britain would be isolated in a war against Iraq, and that a conflict
could be prolonged and draw in other countries such as Israel and Saudi Arabia. There
is also concern that the United States would have to bear most of the cost of a war,
which some analysts estimate could be as much as $200 billion.

"I think investors are not happy with the fact that [a war] is more or less a
go-it-alone operation" by the United States, said David Gilmore, an economist at
Foreign Exchange Analytics in Essex, Conn. "The geopolitical risks get spread more if
it's multilateral, and the economic cost gets spread more."

As a result, investors have increased their purchases of European government and
corporate bonds at the expense of U.S securities, driving the euro up. Another factor
pushing the euro higher has been interest rates, which are higher in Europe than in
the United States. Gold and some other currencies, notably the Swiss franc, also have
been rising.

The most important beneficiary, however, has been the euro, which hit $1.0803 in late
trading yesterday in New York, up from $1.0362 at the start of the year. In currency
trading, where changes are measured in fractions of a cent, that's a significant
rally.

The impact of a higher euro is mixed and extends to many corners of the global
economy. For many Americans, the main result is that it costs more to vacation in
Europe. A modest Paris hotel room priced at 175 euros a night has risen in dollar
terms from $174 at the start of December to $189 today. A 3-euro glass of Rhine wine
in Frankfurt has risen from $2.99 to $3.25. Tourism and travel companies here are
worried that the euro's rise will mean that U.S. tourists, already spooked by fears of
terrorism, will be still more reluctant to vacation in Europe.

Paul Roll, general manager of the Paris tourist bureau, said the combination of a
weaker dollar and the prospect of war in Iraq was the "worst of scenarios" in
discouraging Americans from visiting his city. Paris may fail to achieve its goal this
year of substantially increasing the number of U.S. tourists from an estimated 1.8
million in 2002, Roll said.

But the currency change also means it is easier for U.S. companies to sell their
products in Europe because a cheaper dollar translates into lower prices. Europe's
central bank in Frankfurt is happy because a stronger euro helps hold down inflation.
European corporations complain that their vital export business is suffering from a
more expensive euro.

It isn't clear how long the euro will keep rising. Economic growth in the United
States, though hardly robust, has been stronger than growth in Europe. If the United
States goes to war in Iraq and wins quickly, the dollar will bounce back, many
currency traders predict. One theory about the dollar is that it is falling because of
the expectation of war but will rise again if war becomes a reality.

"When the U.S. is just talking tough, and not acting, in those periods, the U.S.
dollar usually declines. For some reason, people lose confidence in the issuer of the
currency," said Kenneth Landon, senior currency strategist at Deutsche Bank in New
York. "But when the government takes action, and assuming the action is fast and
successful, then the currency will rebound."

Landon said that was the pattern in the 1991 Persian Gulf War and it could happen
again. "I'm not saying that markets like war, but markets and investors like
certainty," he said.

Nevertheless, the euro should benefit in the long run from another powerful source of
support: The United States imports far more goods and services than it exports. As
long as the United States continues to send dollars abroad to finance what is called
its current account deficit -- the current outflow is more than $1.3 billion a day --
there will be a surplus of dollars abroad, reducing the demand for U.S. currency.

Many economists say the euro's rise against the dollar was overdue. The adjustment was
postponed so long, according to some analysts, because of heavy investments by
foreigners in U.S. stocks during the bubble of the late 1990s. That inflow of capital
has dried up.

"The one thing we knew about the United States was that this kind of deficit cannot
last forever," Daniel Gros, director of the Center for European Policy Studies in
Brussels, said. "The only question was, when will the dollar depreciate."

The euro is used by 12 western European countries, including Germany, France, Italy
and Spain. It made its debut at the start of 1999 in bank accounts, corporate
bookkeeping and exchange markets. It was envisioned as having rough parity with the
dollar, but fell sharply over two years after debuting at about $1.17.

Reaction among Europeans to the euro's rise varies. The European Central Bank in
Frankfurt, which fights inflation, is enthusiastic. A strong euro helps restrain price
increases because imports cost less.

"A strong euro can accelerate the implementation of structural reforms, to enhance the
eurozone's flexibility and productivity," Lucas Papademos, the bank's second-ranking
official, said in an interview published Wednesday in Le Monde. He said any effect on
economic growth from higher export prices has been "limited for the moment."

A very different view has been expressed by Siemens AG, the major German electronics
and engineering company. It warned recently that export orders from European plants
were weakening because of the euro's climb, and that its profits earned in dollars
were falling when translated into euros on its books. The company calculates that a 10
percent increase in the euro's value against the dollar costs it 35 million euros in
cash flow.

Siemens's president and chief executive, Heinrich von Pierer, said at a shareholders'
meeting last week that the eurozone would suffer from losing a cheap currency. "The
weak euro was a free, economy-boosting program for Germany and Europe, but this is
over now," von Pierer said.

Elie Cohen, a research professor at the National Center for Scientific Research in
Paris, welcomed the increased role of the euro in international finance but said the
brake on exports would hurt economic growth. With consumption and investment weak,
only exports have driven the European economy, he said.

"When we find that the Chinese, the Russians want to hold more euros in their
reserves, that is good news for the euro," he said. He recalled that one of the
strategic goals of the euro was achieving "a new equilibrium" between the euro and the
dollar.

But, he said, "obviously, the timing is awful."

Staff writer Paul Blustein in Washington contributed to this report.