Global Policy Forum

Dollar’s Fall Lands Hard in Europe


Carter Dougherty

International Herald Tribune
October 26, 2004

Soaring oil prices and concerns about the U.S. economy are driving the dollar back toward historic lows against the euro, threatening additional pressure on the European economy as it struggles to exit a soft patch, analysts said Monday. After strengthening in recent months, the dollar has reversed course quickly over the last week. This has been driven by continued spikes in the cost of oil and persistent worries that heavy long-term borrowing by the United States will continue unabated, regardless of who wins the Nov. 2 presidential election. The euro rose to $1.2801 from $1.2682 late Friday, the highest since Feb. 18, when it reached a record $1.2930. The pound climbed to $1.8409 from $1.8250 while the dollar dropped to ¥106.745 from ¥107.26

The sharp decline in the dollar against the euro may start to squeeze the nascent export-driven growth seen by Germany and some of the largest economies in Europe, where the high oil price is already starting to crimp consumer spending. On Monday, the price of crude oil topped $55 a barrel, up over 70 percent this year. Speaking to the European Parliament on Monday, the European Central Bank president, Jean-Claude Trichet, cautioned that if oil prices remained high or even increased further, "they would dampen the strength of the recovery both inside and outside the euro area." For the moment, though, the dollar is bearing the brunt of market fears that expensive oil will harm global economic growth. "The currency markets are treating higher oil prices as principally bad for the United States," said Audrey Childe-Freeman, senior European economist with CIBC World Markets in London. The European economy "will suffer" as well as the cost of oil takes money out of consumers' pockets, she said.

Stretched by chronic uncertainty in the Middle East and rising demand in China, oil markets felt a renewed shock on Monday as the Norwegian Shipowners Association announced plans to lock out oil workers on Nov. 8, escalating a months-long labor conflict. Though the Norwegian government subsequently stepped in to avert a work stoppage, the episode injected one more element of uncertainty over the ability of Norway, the largest exporter after Saudi Arabia and Russia, to deliver 3 million barrels of oil each day as winter approaches in Europe and North America.

Over the past year, the dollar's weakness has reflected continuing unease at the "twin deficits" in the United States - the federal government's massive budgetary imbalance, and the current account deficit. These ballooning figures indicate the extent to which the United States relies on other countries to finance its growth. The trade deficit, the largest component of the current account, reached $54 billion in August, its second-highest monthly level ever. For the fiscal year that ended in September, the federal government spent $412.6 billion more than it earned. Persistently high oil prices, even when coupled with fairly solid economic growth, has fed uncertainties that the U.S. economy, already facing self-inflicted challenges, does not have the capacity to handle shocks from abroad, such as oil prices, analysts said. "At a certain point, oil makes people feel insecure about growth in the United States, and that's happening right now," said Tony Norfield, a currency analyst with ABN Amro in London.

. The political process will not reverse this situation soon, several analysts said. Regardless of who wins the presidential election on Nov. 2, no chief executive will be able to get his hands around the budget deficit quickly. "The fiscal position is unlikely to improve anytime soon," Childe-Freeman said. The dollar peaked against the euro in February, before sliding into a range of between $1.20 to $1.24 through August. By early September, the single currency was taking off again. A decade ago, the dollar - then measure against the Deutsche mark - was at $1.45 in comparison to today's euro, Norfield said. He forecast that the dollar could reach that level again. "The only question in my mind is how high the euro will go," he said.

The current oil shock also marks a reversal of a historic trend in which the dollar benefited from price increases, analysts said. In previous oil shocks, oil producing countries kept the proceeds from their sales in dollars, often with American banks. But since the introduction of the euro in 1998, Saudi Arabia, Kuwait and other countries with limited prospects for investing at home have the option of shoveling their profits into euro-denominated stocks and bonds, a trend that can only push the single currency higher. "With the euro becoming more widely used, these countries have diversified their holdings," said Manoucheher Takin, a petroleum industry specialist with the London-based Center for Global Energy Studies. The stronger euro, though it helps Europe afford dollar-denominated oil, could ultimately chip away at economic growth if it makes exports from euro-zone countries more expensive.

The German government Monday predicted 1.7 percent economic growth for 2005, above most private forecasts. Wolfgang Clement, the economy and labor minister, justified the prognosis based on export sales that would spark stronger domestic demand. Figures released Thursday by the Munich-based Ifo Institute showed continued lukewarm confidence in the German economy's future, but still above-average expectations for exports. "It's only a matter of time before German business starts complaining about the euro exchange rate," Childe-Freeman said. By contrast, the American economy is likely to see little effect from the dollar's weakness against the euro, economists said. The American trade deficit stems principally from its Asian trading partners, above all Japan and China, but China pegs its currency to the dollar, while Japanese officials have hinted broadly that they will intervene against a major drop in the dollar. "The strong euro really doesn't change the picture for the United States," said Joachim Fels, an economist with Morgan Stanley in London. "U.S. exporters will benefit, but only at the margin."

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