Triangular trouble: Euro, dollar
and yuan By Thomas I Palley
For the past several years the euro has
been appreciating steadily against the US dollar.
Given the Chinese yuan and other East Asian
currencies are pegged to the dollar, that means
the euro has been appreciating steadily against
all. This spells trouble for euroland, and it
suggests European policymakers should join with
the US to address the global problem of
under-valued currencies.
The euro has now
appreciated approximately 70% relative to its
historic low against the dollar, set on October
26, 2000. This appreciation has been economically
justified given Europe’s large
trade
surplus with the United States. That surplus
peaked in 2005 and is now gradually coming down as
the Euro appreciates, which is exactly how a
market-based global economy is supposed to correct
international financial imbalances.
Some
in Europe are beginning to raise red flags
regarding this appreciation, but the reality is it
is still within the bounds of reasonableness.
Though the euro has appreciated 70% against its
historic low, it has only appreciated 20% relative
to its January 1999 introductory parity.
That said, European concerns about
exchange rates are justified, but the focus should
be East Asia’s currencies, not the dollar. The key
player is China, which has the largest surplus.
Additionally, other East Asian countries are
rationally reluctant to adjust their currencies
absent a Chinese revaluation, as they fear losing
competitiveness. This means China’s refusal to
significantly revalue its currency against the
dollar is forcing a lop-sided adjustment process
that places the burden of rebalancing the US trade
deficit exclusively on Europe. That is imposing a
deflationary burden on Europe that could easily
undermine the European economy.
Europe is
now experiencing double trouble as its surplus
with the US begins to fall while its deficit with
China is large and growing. Between 2002 and 2006
the European Union’s deficit with China rose from
54 billion euros to 128 billion euros. At current
exchange rates the 2006 deficit was $179 billion,
and the EU Chamber of Commerce expects that
deficit to hit $260 billion in 2007.
In a
sense, Europe now finds itself involuntarily on
the same path that the US voluntarily locked
itself into in the late 1990s. That path is
characterized by rising trade deficits, weakened
manufacturing investment spending, and loss of
manufacturing jobs.
The yuan’s
under-valuation stands to lower European exports
and increase imports from China as spending is
redirected from European produced goods to cheaper
Chinese goods. The resulting increased trade
deficit will directly cost jobs, and reduced
demand and profitability of European manufacturing
companies will reduce investment spending.
Furthermore, European manufacturers will have an
incentive to close plants and shift production and
new investment to China, just as happened in the
US.
These effects are likely to be
especially disruptive from a regional perspective.
Whereas Germany’s high value-added capital goods
exporters may still be able to prosper, the
economies of Italy, Spain, and other Mediterranean
countries stand to be badly impacted.
Additionally, manufacturing in Central Europe’s
new member states stands to be severely affected,
making their integration into the European economy
more difficult.
The bottom line is that by
all reasonable standards China’s currency is
under-valued against both the dollar and the euro.
China is running huge and growing trade surpluses
with both Europe and the US; it has a growing
global trade surplus; and on top of that it has an
even larger current account surplus since its
trade surplus is supplemented by massive foreign
direct investment inflows.
These
conditions suggest Europe and the US have a common
interest in closely cooperating to pressure China
to adjust its currency. Yet, so far, that has not
happened. One reason is that until recently the
euro was under-valued so that Europe had no
grounds for or interest in pressuring China to
revalue. A second reason is that Europe and the US
are in competition for sales to China and each may
fear antagonizing the Chinese government.
This has triangulated Europe and the US to
their disadvantage and to the benefit of China.
The implication is that fixing the structural
problem of triangulation and remedying the failure
to cooperate on the China currency question should
be urgent policy priorities for both sides of the
North Atlantic partnership.
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