Take China’s exchange rate, for example. The renminbi–fixed at 8.3 per U.S. dollar since 1994–is an important pillar of the Chinese economy, underpinning that country’s spectacular export growth. China just surpassed Japan and is now the world’s third largest exporter after the United States and Germany. Lately, however, many Americans have begun to complain that the renminbi is too cheap. Millions of Chinese and others are bringing back their U.S. dollars, hoping to profit from a revaluation. If that happens, Chinese exports will be more expensive, and prices inside China will also increase as the cost of imports rises. China’s precarious financial system could suffer, and a political crisis might ensue. The renminbi cannot hold at 8.3 forever. But is unlikely that it will be worth anything different from 8.3 in the next 12 months. If it is, we will all feel the consequences regardless of where we live.
The effects of a more expensive euro, which has risen nearly 14 percent against the dollar this year, are already being felt. Last month Volkswagen announced that its financial results were hurt by the cheaper U.S. dollar. Coca-Cola gave the same explanation for its growth in earnings. The results of these two companies are not exceptions but examples illustrative of a wider trend: if the euro continues to strengthen, as is likely, the enormous gap between economic growth in the United States and Europe will continue. As Gerard Baker wrote in the Financial Times, in just the three months of this past summer the U.S. economy grew as much as the entire economy of Belgium. Admittedly, a large fiscal and trade deficit, huge consumer spending and the continuing willingness of foreigners to buy U.S. Treasury bonds all help power the U.S. economic engine. Clearly, this is not sustainable, and it is therefore easy to dismiss an economy that suffers from such imbalances.
But it is also very easy to underestimate the resilience of the U.S. economy–and in particular the competitiveness of its private sector. In the past five years or so U.S. companies have gone through a massive restructuring. The process was painful–millions of people lost their jobs–but the financial recovery of these firms is now showing how useful it was. U.S. companies had already become superproductive when the dollar was more expensive than the euro. Now, with the favorable exchange rate, they’ve got an additional weapon in their arsenal. Pity the European CEO who has to face lean, well-funded, technologically advanced American companies while simultaneously having to deal with rigid labor rules, narrow financial markets, slow-moving banks and bureaucratic inertia. Many European business leaders will instinctively seek help from their politicians. Demands for protection, subsidies and other compensatory measures will increase, and some will be met, exacerbating the trade rift between the United States and Europe.
More generally, the transatlantic relationship is not good–and the combination of a strong euro and the U.S. electoral campaign will not improve it. There are many frictions, resentments and misunderstandings–the Iraq war and trade tops among them–and some may get insufficient attention while President Bush and his Democratic rival fight for the White House. While the U.S. economy is growing rapidly, it is still not producing many new jobs. That pressing domestic issue, not Europe, will grab America’s attention in the run-up to the election.
Bush is somewhat vulnerable on the war issue. Americans have been sobered, at the least, by the rising toll of dead and wounded U.S. soldiers (1,639 as of last weekend) in Iraq. Yet here is where another important number matters. Despite the problems brought on by the war, George W. Bush already has $175 million to spend on his re-election campaign. That number, set against the modest $25 million that Howard Dean, the best-funded Democrat, has raised, will make the U.S. president tough to defeat. That is, unless some of these vital issues shift in an unfavorable way. It’s possible that U.S. economic growth could stall. The casualty figures from Iraq could, and surely will, rise. China’s exports may cause new problems for the White House. President Bush, and everybody else, will be watching the numbers.
