Liking the Euro
The new currency is looking stable relative to the dollar.

Mr. Malpass is the Chief International Economist for Bear Stearns.
December 17, 2001, 8:00 a.m.

’m changing my view on the euro.

In the past, I’ve argued that it would continue weakening in a trend line versus the dollar, and that euro rebounds such as the ones in December 2000 and August 2001 would be temporary. But the euro has moved into a more stable phase relative to the dollar.

Over time, a more stable euro will have positive implications for Europe’s investment rate, which faltered in the late 1990s as capital shied away from euro weakness. In the near term, however, one can still expect Germany’s recession to deepen and Europe to fall into a mild recession. Reasons why there was a weakening trend for the euro included the big negative growth differential between Europe and the U.S., the structural deficiencies in Europe’s socialism, the flaws in the European Central Bank’s monetary policy concepts, and the U.S. policies causing an ever-strengthening dollar. But here are the counter-arguments for a more stable euro/dollar trendline going forward:

• The European Common Bank is in a position to cut interest rates substantially in 2001 from the current 3.25% level as inflation falls and growth weakens. You can even expect more rate cuts in Europe than in the U.S. going forward. The ECB’s policy of targeting the backward-looking CPI inflation rate, decidedly harmful to the euro in 2000 and 2001, will work in Europe’s favor in 2002.

• The ECB is in a good position to build confidence in itself and its monetary policy. Europe’s inflation rate is falling and will likely settle into an attractive range in 2002 — not-too-much, not-too-little. Since its inception, the euro has held relatively stable against gold and commodity prices, more so than the dollar.

• The U.S. has had the sense of a sharp rebound from September 11 — but that feeling of a rebound will be short. It supported the dollar in October and November, but will give way in coming months to the reality of a ragged bottoming process.

• One of the engines behind the 1999-2000 dollar/euro trendline was the extent of the U.S. growth advantage over Europe. While average U.S. growth going forward will still be above Europe’s, the differential won't be as strong as in 1999 and 2000.

• As the U.S. dollar strengthened in 1997-2000, the U.S. benefited from a heavy investment inflow in search of currency appreciation. There was an overwhelming momentum play into the dollar and the U.S. But that imbalance has subsided in the aftermath of September 11 and the resulting changes in U.S. monetary policy to break the U.S. out of its deflation spiral.

• Finally, the advent of the physical euro on January 1, while expected to be inconvenient for a few days — including possible strikes in France — will complete Europe’s commitment to the unified currency. It will add to the benefits Europe gets from using the euro.

For the forseeable future, you can bank on a more stable euro/dollar trend going forward, a positive for European and global growth as it materializes.