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30 October 2000

The euro’s nervous breakdown

The euro is at an all-time low. Does this spell doom for the currency, or just teething problems?

By William Keegan

In a variation of pathetic fallacy, one is beginning to feel sorry for the euro and all who sail in her. It was a bad omen when, during the first weekend of May 1998, the leaders of the European Union spent all day arguing over who should be the president of the European Central Bank (due to come into being the following month) and for how long. The acrimonious dispute overshadowed the remarkable agreement on the exchange rates at which the new currency would be launched on 1 January 1999.

There was a great deal of bitterness, particularly between the Germans and the French, the leading champions of the euro, but also among some of the other countries. It was all about who should become the president of the ECB: Jean-Claude Trichet or Willem (Wim) Duisenberg, a Dutchman.

Trichet, the governor of the Bank of France, was of course the French candidate, and Duisenberg the German one – I’m so sorry: Duisenberg, the president of the Nederlandsche Bank (the Dutch central bank), was the Dutch candidate. As it happened, the politics of the thing dictated that the Germans, having already ensured that the ECB’s statutes would make it even more independent than the Deutsche Bundesbank, could not be allowed to put in their number one choice – Hans Tietmeyer, then the president of the Bundesbank.

The politics of this were so well understood that they barely needed to be discussed. What did need to be discussed was why the de facto German number two candidate, Wim Duisenberg, should secure the post in preference to Trichet. The fact was that when it became clear that the French could not get their way over Trichet, back they came with Plan B: that Trichet should be allowed to take over halfway through Duisenberg’s first term.

It was ironic that the UK – the leading exerciser of the “opt-out” clause – should have had to sort out the dispute. At one stage, the ever-reasonable Tony Blair apparently said to Jacques Chirac: “I don’t understand what you’ve got against Mr Duisenberg”, to which Chirac replied, pointing a finger: “Look at him. He’s a shambles.”

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And a shambles the euro has so far proved to have been. Within months of its proud inauguration – at a value of $1.17 to the euro – the new currency was being described as “beleaguered” and, as if it had been around for decades, as hitting “a new lifetime low”. (It is now valued at less than 83 cents.)

The most commonly cited explanation for the euro’s problems is the sheer strength of the American economy and the latter’s prolonged boom. This explanation, however, does not quite tally with the strength of the Japanese yen against the dollar during this period, despite the much-publicised weakness of the Japanese economy in recent years.

Ever since the breakdown of the Bretton Woods system in 1971, there has been a tendency for the major currencies to fluctuate widely, indeed wildly, against one another. This is one of the reasons why, first, the exchange rate mechanism (ERM) of the European Monetary System was launched in 1979. It offered the chance of “a zone of monetary stability within Europe” in what was then a turbulent world.

And, in that sense, the euro has been successful. The deutsch-mark, the franc and the lira no longer fluctuate against one another. Most Continental countries’ trade is with one another; and, for all the fuss, the devaluation of the euro has assisted the recovery of the Continental economy from a long period of relatively low growth.

Trade with one country outside the eurozone has especially prospered: the weakness of the euro against the pound has put British firms under considerable competitive pressure. Many UK businesses are barely making profits on their exports, and are switching to the Continent as a source of supply.

The decline in the euro against the dollar can be seen as one of the typical fluctuations between the major currencies that have occurred since the collapse of the Bretton Woods system. To add to that, when the euro was inaugurated, the German mark was standing relatively high against the dollar.

The delicate matter of the euro’s problems has been handled with total ineptness. While Trichet has been loyally and consistently saying that “the euro has potential for appreciation”, the ECB in general, and Duisenberg in particular, has gone out of its way to emphasise that, under the bank’s statutes, all that really matters is price stability. Thus intervention – official buying and selling of a currency on the part of central banks in order to stabilise it – has been dismissed as an arm of counter-inflation policy, but otherwise of no interest to the ECB.

Admittedly, the ECB has not been helped by the disarray among European governments. The problems with any “one size fits all” policy would obviously be greatest at the earliest stages of any economic and monetary union.

At the Group of Seven meetings of finance ministers this year, European finance ministers were divided about whether the decline in the euro had become destabilising, and so required official action. As recently as April, the French and Italians wanted intervention, but the Germans seemed happy with the impact on exports and investment (to areas outside the eurozone) of an “ailing” cure.

The concerted intervention by the G7, en route to last month’s meeting of the World Bank and the International Monetary Fund in Prague, was important and impressed the markets. That is why Duisenberg’s recent gaffe was so disastrous: on 16 October, the Times published an interview in which, responding to a question about whether it would make sense for the central banks to intervene in the market if a sharp change in currencies were caused by a war in the Middle East, he told Anatole Kaletsky: “I wouldn’t think so.”

After Duisenberg had come as near as he could to apologising for such ineptness, and put intervention back in the ECB’s official armoury, we had our own Tony Blair upsetting the currency just three days later, by declaring: “If you came along to me with an opinion poll and said, ‘Do you want to join the euro today?’, I would say no.”

Blair has already undone part of the good work of the G7 intervention of 22 September by saying on Sir David Frost’s programme (two days later) that he did not expect any more interventions. The whole point of such action is that it should surprise the financial markets, put them on their toes and stop them speculating further against a currency.

So where do we go from here?

The philosophical climate in these matters is still predominantly free market and anti-intervention, but the G7 did not embark on last month’s effort to stabilise the euro for a bit of fun. There are serious concerns about the strength of the dollar, the weakness of the euro and the possible consequences. For instance, the markets suddenly lost confidence in an America that is borrowing $1bn a day from the rest of the world to feed its appetite for consumption. If Wall Street were to collapse, the US’s role as “importer of last resort” would grind to a halt, and there would be a strong chance of a world recession. Already, US multinationals are feeling the pinch from an overvalued dollar.

Having achieved a “zone of monetary stability” within Europe, we now need to think seriously about a world of less currency instability. The former US Federal Reserve chairman Paul Voicker has expressed deep concerns about the way the value of the dollar and the yen fluctuated against each other by 50 per cent over two years.

And the euro? If the financial markets were suddenly to lose confidence in the dollar, we would find the euro shooting up. And, given the way the financial markets tend to over-react, the next challenge for the ECB and G7 might be to intervene to stop the euro from rising too high. I said “might” . . .

William Keegan’s 2066 and All That is published by iynx (£6.99)