Euro So Beautiful

The euro hit a record high against the dollar. Jurgen Reinhoudt says this is good for the prestige of Europe, but not so good for its economy:

If the Euro eclipses the U.S. dollar as a reserve currency, the value of the Euro could appreciate still further, making European exports even more expensive than they are now (in addition to causing severe troubles for the United States). In French political terms, this would be a highly undesirable development given that “an exchange rate of $1.40 would endanger” the survival of Airbus. As Airbus struggles “to meet $220bn of dollar contracts from an operation with euro labour costs,” the heat is on. No French political leader would tolerate Airbus going bankrupt, certainly not if a bankruptcy were caused by a European exchange rate considered to be abnormally high.
But a Euro worth more than $1.40 (or even $1.50) would not just be problematic for Airbus or French exporters. True, Germany and countries that are economically closely linked to it (such as the Netherlands) have the ability to withstand the pressure of an expensive Euro, but France, Spain, and Italy do not.
A Euro worth more than $1.40 would cause significant difficulties for Mediterranean countries in general—potentially re-launching the political debate over the mandate of the European Central Bank, something that both Sarkozy and Royal have hinted at.
Unlike the American Fed, which has as a goal to keep growth high, unemployment low, and inflation low, the task of the European Central Bank is simply to keep inflation low, even if this adversely affects economic growth. If European growth were to falter and the Euro were to rise even further in value, many politicians from Southern Europe and France will put heavy pressure on the ECB to lower interest rates. This would lower the value of the Euro but also lead to higher inflation, the mortal enemy of the ECB. It would have all the makings of a fascinating financial feud.
The discomfort brought about by the Euro’s “low” value to the dollar was mostly a matter of prestige. Now that the Euro is worth far more than the dollar and still rising in prestige (and value), its value is becoming a matter of tangible economic and political concern. Stay tuned.

Posted by on April 28th, 2007 at 10:04 pm

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