South-Western College Publishing - Economics  
Euro Continues to Rise
Subject Appreciating Euro
Topic International Finance
Key Words

European Central Bank, Currency Markets, Appreciation and Depreciation

News Story

As the euro's rises on world currency markets, European products become more expensive for the rest of the world and European exports fall. This appreciation of the euro parallels and enforces the continuing fall or depreciation of the U.S. dollar in global financial markets, worsening the net export position of European economies.

With this continuing worry about the rising euro, many analysts are frustrated by the fact that the European Central Bank has done little to alleviate the situation. Normally, central banks intervene by buying or selling currencies in amounts large enough to influence their value. To date, the European Central Bank has not chosen to do so, although growing pressure is mounting as the euro appreciates against the dollar and threatens European exports to the United States. Such a situation would severely affect Europe and Asia as well, because they rely heavily on exports to large U.S. markets for their own economic growth.

If the European Central bank is planning such an intevention, it certainly is not saying so publicly. Bank president Jean-Claude Trichet recently commented on the usefulness of currency intervention as a solution to the problem, but declined to indicate that such a move was imminent.

Trichet reiterated previous statements about the rise in the euro against the dollar by saying that rapid changes in exchange rates were "not welcome". He then ended his statement by saying, "Verbal discipline, at the present time, is really of the essence".

Intervention in currency markets can be more successful when countries team up to accomplish the same goals. Europe may find an ally in the Bank of Japan. Rumors have been circulating that Japan may be partner in slowing the depreciation of the dollar against both the euro and the yen. Hiroshi Watanabe, a senior official in the Japanese finance ministry, was quoted as saying that Japan and Europe could take "harmonized action" in an effort of dampen the appreciation of their currencies against the dollar.

Even with such "harmonized action", the effort would almost certainly not have the support of the U.S. Federal Reserve, which currently seems content with the value of the dollar and the narrowing of the U.S. trade deficit. The current situation with the euro and other currencies is not a home-grown phenomenon, but rather a result of the depreciation of the U.S. dollar on global currency markets, so European options are limited. As long as the United States continues to tolerate a weaker currency, it will be very difficult for the European Central Bank to intervene in currency markets with much success.

(Updated February, 2005)

Questions
1.

Discuss how the falling value of the dollar worsens the net export position for European economies.

2. Why does the depreciation of the dollar against other currencies reduce or narrow the U.S. trade deficit?
3. Discuss how currency intervention can affect the value of various countries' currencies.
Source Mark Landler, "Central Bank Remains Silent as the Euro Rises," The New York Times Online. December 3, 2004.

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