Sunday, April 18, 2010

The Euro at $ 1.60 ?

According to Martin Feldstein the euro is not overvalued and a further downward slide is unlikely. On the contrary:

« Looking ahead, the euro is more likely to climb back to the $1.60 level that it reached in 2008. »

There are two main reasons: the first is that Germany, Europe’s largest exporter, has a very large trade surplus with the rest of the world, a surplus equivalent to nearly 6% of GDP. And a surplus, Feldstein believes, that would remain high even if the euro appreciated substantially from its current level.

Moreover, global economic conditions require the euro zone to have a substantial trade and current-account deficit so that it becomes a large importer of funds from the rest of the world. Mostly because oil producing countries and China will continue to export more than they import, and because these surplus countries will diversify their investments away from the US and into the euro zone that provides the only large capital market other than the US for such investments.

Central banks in Asia and the Middle East will do the same with their foreign-exchange holdings, and this will inevitably cause the euro to rise relative to the dollar.

My comment: Feldstein’s argument really is about who should bear the burden of the realignment of the dollar-yuan exchange rate. The Chinese government is reluctant to revalue the yuan vis-à-vis the dollar, and if he does so he would not like to revalue at the same time its currency against its other major zone of exports, Europe. It follows also that the US would find it much easier to devalue the dollar both relative to the yuan and relative to the euro. In that way the effort required from China, and from the US, would be less and the euro zone, a global net exporter, would bear part of the burden.

This makes sense for Germany of course. But is is nonsense for other members of the euro zone that are currently net importers. Their activity would be further depressed by the move. And the political tensions within the zone would be much increased, with some countries considering exiting the zone even more seriously that they currently do. A problem that Feldstein analyzed in a previous column “Can the Euro Zone Survive Economic Recovery?” (November 25, 2009).

The balance of costs and benefits of being a member of the zone will thus be further affected by the dollar-yuan realignment, and the very survival of the euro possibly jeopardized.

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