Posted: December 26, 2004

Euro zone madness continues

In the UK Financial Times article by Darryl Thomson, Dollar falls to fresh lows in thin festive trade posted December 24, the continued slide of the USD against the Euro is put down to "disappointing US economic data" (mostly sharp slowdown in new home sales). However, a so-called currency strategist claims it is the "deficits rather than the data which were weighing on investors minds". The hoary old neo-liberal twin deficits attack on public spending is making a comeback. The strategist claims that the "The market was already concerned about how the US will tackle its huge double deficits and its commitment too this. The US gives the impression it remains unconcerned with the dollar’s fall. Depreciation helps reduce the deficit."

The reality is that the US deficit is currently too small relative to GDP as evidenced by the rising unemployment in that country. The current account deficit is just a sign that there are foreign interests who wish to accumulate (save) in USD-denominated financial assets. This is allowing the US economy (and consumers) to enjoy imports with less exports! A correction will come when the rest of the world desires less saving in USD-denominated financial assets. At that point, the gains from the favourable terms of trade will diminish. But this is unrelated to the need for the US government to increase net spending to ensure job creation is sufficient to fully employ their willing labour force. The risk in the US is deflation (following the Japanese route) not inflation.

The problem is compounded by the incompetent monetary policy stance of the ECB. They refuse to purchase USD in the currency markets (for fear of using the USD as a support currency) but in doing so they prevent essential Euro liquidity injections into the world economy. The squeeze on their export sector is a result. They should follow the example of the German Bundesbank in the 1970s which kept their industrial sector competitive on world markets by ensuring they bought USDs to keep the Mark from appreciating. Euro-zone countries should abandon the fiscal discipline of the Stability and Growth Pact and increase net government spending (deficits) and further allow the ECB to use all the monetary policy instruments and move away from a singular reliance on interest rate setting to stimulate their economies. However, if the Stability and Growth Pact is going to remain with its destructive fiscal policy implications, then at the very least the ECB should be "net spending" through forex strategies. For the Euro countries, the failure of the ECB to act once again signals the failure of the "Brussels-Frankfurt consensus" to tackle the chronic unemployment in Europe which is over 10 per cent in many countries.

The European failure to understand the correct macroeconomic policy approach to their low growth, high unemployment malaise is captured by the comments of the Dutch finance minister Gerrit Zalm who said that the "euro is moving within a range which is still acceptable." The FT report suggests that "concerted ... [ECB] ... intervention is a long way off." Zalm went on to say that he "hoped the European Central Bank would increase its key interest rates soon from 2 per cent" to prevent any inflation from arising as European growth began. Spare the thought that he might become unemployed as a result!

Blog entry posted by bill