The race to the bottom in currencies could get more competitive.
The dollar has a nice head start, having dropped 16% over the past year against a basket of major U.S. trading partners. But the benefits of a weaker currency – cheaper exports, the ability to stick it to your creditors by repaying them with less valuable paper, abundant opportunity to blame your problems on hapless central bankers – aren’t lost on people outside this country.
The euro is “objectively overvalued in comparison with other major reference currencies,” Eurogroup chairman Jean-Claude Juncker said Monday afternoon. The comment comes as the euro, up 22% against the dollar over the past year (see chart, right), trades near a 52-week high at $1.47 even as the Greek debt crisis threatens to erupt.
Juncker made the remarks in Strasbourg, France, as he and another top European official, Olli Rehn, tried to make the case that the Greek mess needn’t lead to a financial crisis.
But if Greece’s unbearable debt burden is the acute problem, the chronic one is the currency that ties together financially weak and strong states without giving the weaker ones any recourse to improving their competitive positions, short of sharp wage cuts.
That is a problem in putting Greece and Portugal in the same currency union as Germany and France at any rate, but the higher the euro exchange rate go the more intense the pain gets in the weaker states. Juncker suggested officials will have to consider this as they adopt reforms to what is obviously a broken union.
“There are colleagues in the European Council who think that the euro zone should have an exchange rate policy,” he said. “I’m more inclined to think that we should have an exchange rate policy because in a structurally globalized world an economic and monetary unit which doesn’t even have a vision of an exchange rate policy isn’t really in the long run going to have a satisfactory profile.”
Yet even with a prominent official calling for a weaker euro, it’s far from clear that markets will be in any hurry to comply. A run of weak numbers has economists referring as one to the “soft patch” in U.S. data, and few expect it to end any time soon.
As long as the U.S. economy wheezes and the Federal Reserve keeps interest rates near zero, money is likely to keep flowing to Europe, where rates are higher and the European Central Bank has signaled it intends to further tighten policy soon.
What’s more, while Europe obviously isn’t exactly setting any records in responding decisively to the Greek crisis, it’s hard to overstate the scale of problems facing U.S. policymakers – or their failure to devise something approaching a coherent response. This too is apt to keep funds flowing away from the dollar.
As Bank of America economist Ethan Harris writes in a note to clients Monday:
Despite the ongoing recession in the housing market, there is no serious discussion about how to resolve the crisis. Despite a 9% unemployment rate, there is no serious discussion about how to speed up the job market recovery. And despite clear signs of economic weakness, there is no let-up in the pressure for quick monetary and fiscal tightening. The U.S. needs to set a clear path to debt sustainability, but the timing of tightening should be dictated by the strength of the recovery.
Of course, Congress being Congress, what should happen is anything but a sure thing. As long as the Greek crisis stays on the back burner, the dollar looks unlikely to give up its lead spot in the race lower.