The Sick Euro

["廖子光 Henry C.K.Liu 郭??" <hliu@xxxxxxxxxxxxxx>]

David Roche, global strategist at London based Independent Strategy, wrote
yesterday (May 4, 2000) in the WSJ that the euro needs a supply-side boost.
His argues that the fall of the euro by almost 25% from its launched value in
January 1999 (at this writing hitting below 90 cents) is caused by Eurozone's
denial of the new economy, excessively high tax take (50% of GDP compared to
35% in the US) and excessive size and growth of the state sector. The euro is
weak because Eurozone is a less desirable place to do business, Roche
concludes.

Roche is arguing classic Freidman monetarism, a view always welcome in the
op-ed pages of the WSJ.  Yet the same data can be interpreted in very
different ways.  The new economy is showing signs of a bursting bubble
worldwide, the US economy is about to enter a confusing and dificult phase. US
government surplus may not turn out to the the blessing that conservatives
imagine and privatization of social services are leading to bankruptcies after
deterioration and maldistribution of services, and Schumpetrean "creative
destruction" is turning out to be mere old-fashioned trade restraining
destruction than true creativity.

The Social Democrats in Euroland simply lack the political will and ideology
faith to sustain a strong euro.  The so-called Third Way is simply hooking up
an old economic piston engine to supersonic arodynamic rhetoric. The Third Way
has all the right looks, but it lacks supersonic speed to benefit from its
streamlines.
Euroland political leader may actually prefer a weak euro since such
development directly benefits the export sector.  But a falling euro
discourages investment in Eurozone and it is more inflationary in the long run
because a weak currency artificailly inject real inflation into local assets.
For Eurozone residents, a falling euro means deflation at home and inflation
abroad.  It is the surest way toward second class economic citizenship in the
game of globalized finance.

The ECB is institutionally committed to historical fears of inflation.  It is
prepared to pay any price to maintain "price stability of currency." In a
slowing economy, stable price of money through rising interest rates means
deflation of general assets and falling real profits for external capital that
invests in Eurozone, not to mention the impact of high interest rate in
slowing down the economy. In an era of free exchange rates and cross-border
fund mobility, central bank intervention in maintaininng the exchange value of
any currency will only exacerbating the undersirable trend it tries to
counter, either up or down, distorting market im0plications, turning market
impacts into structural defects and delaying retoration of equilibrium at a
more desirable level.

When the market is facing overcapacity and overproduction, caused by
overinvestment, and out-of-sync productivity growth, monetary measures have
very limited effect.  There are two ways to correct overcapacity: 1) layoffs
and shutdowns and 2) expansion of consumption.  The latter way is less
painful.  Tax cuts will stimulate consumption in some situations. But in the
current scheme of things, tax cuts direct money to the high income groups
whose marginal consumption demands are low and inelastic with further income
growth. A tax cut in fact stimulates more investment than consumption.

Thus fiscal measures appear to be the only alternative.  Yet physical
infrastructure spending is slow impacting and of diminishing return.  In
Europe, its hard to imagine how amny more roads can be built with economic
efficiency.  Social infrastriucture, such as education, health, environment,
high worker benefits may be the only solution. Fiscal measures, by definition,
is in the public sector.  This makes Roche's doctrinare arguments inoperative.

Meanwhile, the Bank of England elected to keep repo rate at 6%.  The decision
to resist raising the British repo rate helped both the yen and the euro
against the dollar.

Henry C.K. Liu