What Goes Up…

The new line of panic from the economic worrywarts is the value of the dollar falling against the Euro. Granted, currency devaluations are a dangerous game, and while they provide short term beneifts, over the long term they can wreak economic havoc. However, despite all the doom and gloom, the fears over the dollar and the “strength” of the Euro are both based on a myth. The underlying realities show that world currency markets are skewed against the dollar, but the fundamentals will restore the balance as the Euro slides and the dollar rises.

Bloomburg notes that the rise of the Euro is transitory based on the US’ economic growth:

U.S. 10-year Treasury notes yield 0.6 percentage point more than German debt with the same maturity, near the four-year high of 0.61 percentage point reached on Dec. 16, according to data compiled by Bloomberg. The gap may widen as U.S. economic growth exceeds Europe’s, said Niels Christensen, a foreign-exchange strategist in Paris at Societe Generale SA.

“If it’s down to fundamentals and economic growth, there is no justification for a stronger euro against the dollar,” said Christensen. “The yield gap is an important factor” that may help the dollar advance to $1.32 per euro in three months.

Evidence of this can be seen in the latest estimates of economic growth from the Organization foe Economic Cooperation and Development. The OECD conservatively estimates that the US economy will grow at a rate of 3.3% over the next year, with the Eurozone set to expand at a much lower 1.9% – and that may be optimistic. The structural problems with the EU economy remain. The unemployment rate in the EU remains at a high 8.9% with the unemployment rate in France at an above-average 9.5% and the German unemployment rate at 9.9%. When 1 out of every 10 workers is without a job, and productivity is significantly lower per worker than the US, you don’t have a recipe for stable economic growth.

The primary reason for the massive growth of the Euro compared to the dollar lies in the differing interest rate policies of the Fed and the ECB. The Fed lowered interest rates to increase liquidity and get the sputtering US economy back on track. The ECB did not, meaning that the Euro is on the cusp of a massive deflation.

And it is this pending deflationary crisis that is proving the prescience of the Euro-skeptics. The Eurozone is heavily dependent on exports, and the dollar’s fall relative to the Euro makes European exports prohibitively expensive for foreign buyers. This could take that projected 1.9% growth and not only reduce it, but perhaps cause the Eurozone to shrink. In the near term, the fall of the dollar should be of less worry to American policymakers than it should be to Europe. Especially with the US manufacturing sector enjoying the benefits of US exports being significantly cheaper on the global market, the dollar “crisis” is less of a problem than it is an opportunity.

One also wonders how much of the dollar’s fall has to do with a certain prominent currency trader and frequent Bush-basher who would have every interest in seeing Bush embarrased and has a history of currency speculation for political gain.

Over the long term, US policymakers are doing the right thing. The Fed is slowing raising interest rates to combat inflation. Bush has promised to cut the deficit, and he has a Congress that may be more willing than ever to cooperate with him. US economic growth continues to be stable and strong.

There’s an old saying, what comes up must come down. The question is how long will it take before the overvaluation of the Euro and weak economic growth causes the nearly inevitable deflationary spiral.

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