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The Ties Between Growth and Currencies

November 12, 2010
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As world leaders meet in South Korea to discuss international trade and finance, Eurostat released the growth rates for the members of the EU (see chart below).  This data helps put the current G20 debates into perspective, since the many of the major economies of Europe are doing poorly compared to the U.S., yet the two sides of the pond are dealing with the global recession with different tools.  While government austerity is sweeping across Europe, the U.S. actually decided to spend more money as the Federal Reserve Bank (the U.S. central bank) recently announced that it would spend $600 billion in quantitative easing.

Most Americans will feel the effects of this policy as interest rates decrease, but the Fed’s actions have annoyed the rest of the world, since it helped push down the value of the dollar, making American exports cheaper and imports more expensive.    In fact, the euro shot up to €1 = 1.42 on Monday, which is the highest the euro has been since January, before sliding back to about $1.37 on fears of the Irish government having trouble paying its debt.  In fact, Irish bond rates reached record highs on Wednesday of 8.28% (or 6.19% above Germany’s rate) and the EU has been forced to declare it is ready to support Ireland.

 

This euro appreciation has upset Germany, as it is the second largest exporter (after China) and the engine of European economic growth.  As the above chart shows, while the German economy is still growing faster than the American economy, it has slowed considerably 2.3% in the second quarter to 0.7% in the third quarter (compared to previous quarter).  Of course, if the dollar were to appreciate, German exports would increase, but American exports would decline in turn, and as the last few blog posts have shown, many American states are benefiting from the cheap dollar.

 

The result could be a “currency war” of competitive devaluation, but the G20 has agreed today not to go down this path.  However, the same group was unable to agree on any reforms of trade imbalances, which is a major concern.  Germany would be opposed since exports are the driving force of its economy, while the U.S. would like to have a smaller trade deficit, in turn hurting global exporters such as Germany.   As a result, the government debt crises in Ireland and Portugal have a direct effect on Germany and the U.S.—including Indiana.

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