$/Euro dynamics

[Eubulides <paraconsistent@xxxxxxxxxxx>]

Illusion of grandeur

The dollar's weakness is buoying up the euro, but that's not necessarily
good news for the eurozone economies, writes Mark Milner

Monday November 24, 2003
The Guardian

During the next couple of days the eurozone finance ministers will be
wrangling over what to do with France and Germany's failure to comply with
the stability and growth pact.

The European commission upped the stakes last week when it said it wanted
Germany to cut its budget deficit by more than the Berlin government
reckons it can afford.

It is a classic row. The commission argues arguing that eurozone countries
should stick by the rules, while backsliders warn that doing so would
choke off recovery.

In the normal run of things, the tug of war over the stability and growth
pact would have policy makers twitching with concern about the credibility
of the euro. The slightest sign of weakness from the euro would have been
interpreted as collateral damage from the battle over the pact. But
instead, the single currency has climbed against the dollar to levels not
previously seen in its short lifetime.

Signs that the US economy is turning feisty while that of the eurozone
remains flat merely add to a sense of perversity. European policy makers
should not run away with the idea that the euro has become the darling of
the foreign exchange market. It hasn't. It is simply that investors prefer
it to the dollar, and these days that isn't saying much.

The factor giving the euro an unexpected edge is the ballooning US trade
deficit. Even the septuagenarian billionaire, Warren Buffett, the sage of
Omaha, has confessed that for the first time in his life he has holdings
in currencies other than the greenback. Mr Buffett cites the parlous state
of the US current account - the broadest measure of trade - as evidence
that the US may be living beyond its means.

Last week, portfolio investment data showed that international investors
are turning leery too. Net inflows were the lowest for five years, and US
policies haven't helped much either. The decision to slap quotas on some
Chinese textiles added political ineptitude to economic disquiet.

While China needs access to the US market to keep growing, the US needs
China to recycle its trade surplus into buying dollar assets. If Beijing
were to decide to stage a buyer's strike, the dollar would be left in an
uncomfortable position.

But, for some, the euro's position is uncomfortable, too. The commission
and the European Central Bank may argue that currency volatility is more
worrying than actual exchange rate levels.

Tell that to Germany's exporters who will have to lead the country's crawl
out of the economic mire. They fear the euro may not only hit $1.20 but
even top it, laying waste to export prospects. As long as the dollar stays
out of favour, it will remain a brake on the eurozone.

Still, finance ministers will be able to indulge in a decent bout of
squabbling this week without having to keep a watchful eye on the foreign
exchanges.

· Mark Milner is the Guardian's deputy financial editor.