How the Europeans propped up the dollar
Joel Kurtzman (archive)
June 15, 2005
Since 1971, the dollar has had no real-world backing other than the level of confidence the rest of the world puts in the United States and in its future.
Interest rates play a part, but people are willing to forgo a basis point or two of today’s returns if they believe tomorrow’s yields will be even better.
With regard to confidence in the United States, there have been ups and downs. The dollar sagged under Carter, rose under Reagan, fell under the first George Bush, rose dramatically under Clinton and lost 40 percent of its value under the second George Bush.
The recent dramatic fall in the value of the dollar has led to slower global growth, higher oil and commodity prices, tensions with China and increased inflationary pressure. And, if you ask me, it has increased the US trade deficit by making strategic imports like oil more expensive.
But confidence is relative and the question most people ask themselves when they do their analysis is, “if we can’t rely on the US, who can we rely on?” In the run up to the war in Iraq, the financial world put faith in Europe and in the euro.
Money managers liked what French President Chirac and German Chancellor Schroeder said and grumbled about Bush. Financial leaders thought Europe had moxie and its leaders weren’t afraid to chart their own way. They say strength in Europe’s numbers.
But as the vote over Europe’s cumbersome and lengthy constitution began to look more like a “non” than a “oui,” the world realized that on a bet on Europe was a far more uncertain than a bet on the US.
With confidence in Europe’s future waning, the all-mighty euro began to lose altitude. On the day French voters turned against the constitution, the euro lost 2.5 percent of its value against the dollar. It fell further when Dutch voters rejected the proposed 1400-page document which declares, among other things, that every European has a right to a job, but doesn’t say who has to provide it for them.
With Europe’s pro-constitution leaders off licking their wounds, Chirac’s vision of Europe as a second superpower is still a long way off. As a result, there will be no European “counterweight” to US power in the near future, and perhaps never.
None of this, of course, has been lost on the world’s financial leaders. As a result, we are beginning to see a recovery in the value of the dollar, despite falling US interest rates. In my view, the dollar has entered into a long term upward trend in value against the world’s other leading currencies.
This is very good news.
With confidence in the dollar returning, it is very likely that we will begin to see falling oil and commodity prices, which are priced in dollars. Since oil and commodities producers will have seen their purchasing power increased, due to the dollar’s rise, they will be able to pare back prices with no ill effects at home. Commodity prices should start falling soon.
That’s good for world growth.
In addition, with the dollar on the rise, China will feel less pressure to revalue its currency, which is pegged to the dollar. This will allow its leaders to save face and permit them to focus on fixing their domestic financial system, which needs a lot of fixing.
A higher dollar will also mitigate inflation in the US, which will keep interest rates low. And, finally, a higher dollar is likely to return to the US its important role as the world’s consumer of last resort. For the bedraggled economies of the Europe – Germany and Italy in particular – this is the medicine they so urgently need.
Europe’s “non” vote on its constitution, and the world’s renewal of confidence in the US, is good news. Not only because the constitution needs – how shall I put this? – a little more work, but because it recognizes one of the central tenets of this era, namely, that the US is the world’s sole and unrivaled superpower in economic and military terms. A European counterweight to US power may make sense in a Parisian coffee bar, but not in places where real power is wielded.
It may take a time before the dollar re-ascends to its towering height. And, a madman or a global tragedy could always derail even the best of trends. But as the dollar rises, we can expect to see the fortunes of countries improve around the world.
Though President Chirac may protests, no one ever really wins betting against the United States.
Joel Kurtzman is Chairman of the Kurtzman Group, a consulting and advisory firm
How the Europeans propped up the dollar
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Originally Posted by Louis VI the Fat
) we can really start rebuilding our economy. 
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