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What is Happening to the Euro?

October 5, 2010

One must wonder what is happening with the euro.  I have been chronicling the fall and then the rise of the euro since April.  As the below figure shows, the euro reached a six month high yesterday, making it more valuable compared to the dollar today than it was at the beginning of April.  This is despite the Greek bailout in May, an increasingly clear “two-speed” recovery in the Eurozone as Germany and northern Europe versus the infamous “PIIGS,” and the ballooning Irish budget deficit.  (The Economist now has an excellent series of charts that examine the economies and finances of the 27 members of the EU.)

Four months ago, I wrote that the depreciating euro could have an effect on the U.S. and Indiana economies since it would make American exports less competitive compared to products priced in euros (“The Euro Financial Crisis’ Affect on International Trade”).  Well, it is now the Eurozone’s turn to be worried that its appreciating currency will hurt competitiveness.  Central banks across the world have been intervening in the foreign exchange markets to weaken the value of their currencies vis à vis the dollar.  While the media and policy makers on both sides of the Atlantic have tended to focused on the Chinese yuan; Japan, South Korea, Brazil, and Switzerland have all attempted to prevent their currencies from appreciating against the dollar.  Yesterday, the Eurozone entered the fray, as French President Nicholas Sarkozy announced that he wants to place the international monetary system at the top of his presidency of the G20.  Other European leaders have jumped on the bandwagon of asking for China to allow the yuan to appreciate, saying that its set exchange rate is hurting European competitiveness.

Since countries have already started to devalue their currencies, some sort of multilateral action will probably be required to prevent a “race to the bottom.”  For instance, if the European Central Bank were to follow other central banks and devalue the euro unilaterally, the U.S. would probably have to follow suite, since the U.S. also wants to export more.  However, this devaluation would cancel out the others’ devaluations, forcing them to devalue their own currencies, and so on.  NPR ran a story this morning explaining a currency war and the call for central bankers to work together (“World Leaders To Discuss Averting Currency War“).  Instead, there is now talk of action based on the 1985 Plaza Accord model, where all of the major central banks worked together to adjust exchange rates.

I am sure that more news will develop on this event in the upcoming months and the euro will remain in the news.  Hence, the Indiana University EU Center is working hard to inform the Midwest about the euro.

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