If this were true, it would bring healthy balance back to a planet that has been spinning lopsided because of all the foreign money flowing into the United States. But it’s not true. The rise of the euro does not reflect a global vote of confidence in the European economy; it reflects a temporary sentiment of no confidence in United States corporations, due mainly to scandals involving Enron, Andersen, Tyco and a host of others. “We’re anti-dollar, not pro-euro,” says Michael Hughes, chief investment officer for Baring Asset Management in London.
That’s an important distinction. Think of the currency as the share price of a country. Investors like to buy growth stocks like Microsoft because that growth leads to rising share prices. But when growth stocks overshoot and get too expensive, investors switch into defensive stocks–safe, steady plays like utilities. That’s what is happening in the stock market right now, and something similar is happening in the currency markets, as investors shift money from dollars into gold, Swiss francs and euros. Don’t mistake this shift for a bet on the future dynamism of Europe. “It’s a short-term trading position, not a long-term investment strategy,” says Eric Lonergan, global economist for Cazenove in London.
It’s natural that investors would shy away from the dollar after a boom as wild as the U.S. miracle of the 1990s. When U.S. stocks soared, money poured into Wall Street from overseas, driving up the dollar. Europeans in large numbers began discovering the allure of stocks for the first time. That created a European equity culture that turbocharged the rise of the dollar, since the United States makes up 50 percent of the world equity market. The inflow of money allowed Americans to import much more than they exported, running up a huge deficit in the country’s foreign accounts–financed by foreigners who were glad to help so long as they were confident of ever-rising returns. Now the shenanigans at Enron, Andersen and Tyco make them fret that they won’t get their money back.
Those fears won’t last. Before long, investors will come back to the dollar because the United States is still the biggest, boldest market. That’s not likely to change soon, despite recent European efforts at market reform, including the EU’s move to outlaw “golden shares,” which allowed European governments to block the sale of national companies to foreigners. Most forecasters still believe the long-term U.S. GNP growth potential is a full point higher than the 2 to 2.5 percent range in Europe. Many Europeans like to imagine that the rise of the euro confirms that they are catching up, but that’s wishful thinking. In a recent study, Merrill Lynch found that the United States and Japan enjoy a significant productivity lead over Europe, which has done nothing to close the gap in the last 18 months (chart).
Talk of an end to the recent strong-dollar era is premature for historical reasons, too. The geopolitical forces that once backed a deliberate weakening of the dollar no longer exist. Back in 1985 the United States, Japan and Europe agreed that the dollar should come down, and the yen and the Deutsche mark surged for years. This time Treasury Secretary Paul O’Neill may secretly wish to help American exporters, but the Bank of Japan wants a weak yen so that exports can kick Japan out of recession. And for all the posturing by European finance ministers about wanting a strong euro these past three years, the timing is wrong. A robust euro could choke off recovery in the euro-zone nations, especially Germany, by making their exports more expensive abroad. Economists estimate that a 10 percent drop in the dollar would knock half a percentage point off euro-zone growth. Even European Central Bank president Wim Duisenberg, who tried for years to talk up the euro, seems happy to let it plateau for now. And if Duisenberg, a father of the euro, isn’t out promoting his creation, how high can it go?
