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Why the Europeans need to take their complaints about the strong dollar to Beijing

By Peter Morici
web posted October 8, 2007

The euro has risen about 10 percent against the dollar and the yen over the last year, and this is giving European exporters and politicians fits. Predictably, Treasury Secretary Henry Paulson is getting pressure from European colleagues to take action.

No prize for naming who is carping the most. French Finance Minister Christine Lagarde recently stated "I'd really like to hear again Henry Paulson saying loud and clear that a strong dollar is good for the American economy."

From Boeing and Airbus to French winemakers and California vineyards, the Europeans and Americans are locked in intense competition for consumers throughout the world. Hence, it is natural that Europeans get apoplexy when the euro rises too much against the dollar. However, the Europeans should take her complaints to Beijing, Tokyo and other Asian capitals if they want tangible results.

The United States, despite a shrinking federal budget deficit, still has a trade deficit exceeding 5 percent of the GDP, which can only be supported by capital inflows. With the subprime crisis making U.S. debt securities less attractive, the international demand for dollars is falling and currency exchange rates for the dollar are dropping, because exchange rates are the pricing mechanism that clears the market for dollars.

Put simply, the U.S. trade deficit creates an excess supply of dollars on currency markets, and foreigners mop up those dollars when they invest in U.S. bonds and other assets. With private lending to Americans falling, the mechanics of supply and demand are driving down the dollar against the euro, yen, yuan, won, and other key currencies. However, this process is not uniform.

China, Japan, and other Asian mercantilist regimes limit the appreciation of their currencies against the dollar by intervening in foreign exchange and credit markets. The governments of China and Korea, through their central banks, purchase however many dollars it takes to keep their currencies as cheap as they like to keep exports booming. Japan maintains rock bottom interest rates and encourages the carry trade to accomplish its currency objectives. Unable to adjust adequately against they yuan, yen, won, and other Asian currencies, the dollars falls more than it should against the euro, pound and other western currencies.

The Peoples Bank of China leads the pack, buying about $250 billion a year in U.S. and other Western securities and maintaining a trade surplus with the United States of equal size.

Together, China, Japan, and Korea account for 55 percent of the U.S. trade deficit, and their currency manipulation keeps the U.S. deficit with these countries from falling. Petroleum, which is priced in dollars and not much affected by exchange rates, is most of the rest of the U.S. trade gap.

Essentially, the dollar is overadjusting against the euro and other western currencies, because Beijing, Tokyo and Seoul won’t let the dollar rise against the yuan, yen and won. That makes the euro and pound rocket when the dollar falls out of favor.

Beijing leads the pack, with the largest trade surplus with the United States and largest purchases of U.S. dollars.

European finance ministers should take their complaints to China, and stop blaming all their problems on Washington. ESR

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.


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