QUERETARO, Mexico, Dec. 4 (UPI) -- It had to happen. European Union finance ministers decided November 25 not to penalize the French and Germans for breaching the 3 percent of GDP fiscal deficit limit of Europe's growth and stability pact: the pact designed to protect Europe's common currency, the euro. And so the euro lost all credibility and -- soared to new records against the U.S. dollar.
Why? The dollar's fall against the euro has been predicted by Global View over the past couple of years and will continue. It has, oddly enough, little to do with Europe's economic fundamentals and much to do with America's. It doesn't help the dollar's credibility that U.S. President George W. Bush is, like the French and the Germans, no friend of fiscal restraint. But before we turn to why the euro, up to a value of $1.21 now, a rise of over 40 percent on its mid-80 cent lows of 2000-2001, is thrashing the dollar, let's take a spin through Europe and see the good and bad.
The euro is certainly not leaving the dollar behind because European growth is good. The main continental European economies that share the euro currency are likely to advance by less than half of one percent this year while the U.S. economy shot along the road at an 8.2 percent growth rate in the third quarter -- like a hare and on the back of policies that we would see as hare-brained. Europe, meanwhile, is tortoise-like, though not entirely without some signs that it might evolve, one day, into a more nimble animal.
Poor growth and high unemployment -- about one tenth of the workforce in both Germany and France, the two largest continental European economies -- are at last forcing the governments of each country to implement reforms. Whether those reforms will be carried through and are sufficient to make Europe more dynamic -- capable of rabbit-speed, perhaps, if not the mad march of hare Bush -- is in doubt. But a start has been made. Both France and Germany have their agendas out.
Agenda 2010 is German Chancellor Gerhard Schroeder's attempt to revitalize Europe's largest economy. Reform of the state health system, whose costs were spiraling, has been approved but reforms to labor markets and pensions law face strong opposition. According to Jan Friederich, senior economist at the Economist Intelligence Unit in London, the conservative CDU/CSU opposition coalition, which dominates the upper house of Parliament, "would just love to see Schroeder fail with his Agenda 2010," even though it "goes in the direction traditionally advocated by the CDU/CSU."
Since Schroeder the social democrat is trying to carry out reforms long touted by Germany's right, Friederich does expect Agenda 2010 to progress, via compromises. Germany may then go so some way towards creating a more flexible and competitive economy.
France, meanwhile, is four years ahead in its agenda, Agenda 2006, at least in name, if not in terms of getting the necessary reforms implemented. French Prime Minister Jean-Pierre Raffarin enjoys a huge majority in parliament and has already pushed through a pension reform that obliges state workers to work longer in order to obtain the full level of pension.
According to the Economist Intelligence Unit's French specialist, senior economist Philip Whyte, "the major challenge for France in 2004 will be to reform healthcare costs, which have been rising unsustainably strongly for years." Whyte expects that Raffarin will push through the unpopular health reform late in 2004 and then be sacrificed by French President Jacques Chirac.
But introducing greater labor market flexibility in France is hampered by the introduction of a 35-hour maximum working week by the Socialist former prime minister, Lionel Jospin. Raffarin is chipping away at this, by bringing amendments that allow employers greater scope for flexibility but the gains made are marginal and the 35-hour week has clearly taken France in the wrong direction. Nor is France yet tackling the problem of over-manning in the state sector, particularly in the town halls that people even small communities.
Nonetheless the fact that France and Germany are contemplating and/or implementing reforms is a welcome and recent step forward, precipitated largely by the slowdown in the European and world economy since 2000. The reforms may be diluted or not passed at all; will certainly not revitalize growth soon; and are offset by the failure so far to bring down budget deficits. Much more needs to be done. Europe is not rushing to do it, but is at least beginning to do something.
The euro's surge, however, has nothing to do with this progress on reform. It has to do with U.S. frailties, to which international investors are beginning to open their eyes. The United States 4 percent plus budget deficit has helped to push the annual deficit on current account (a full measure of trade, including services and income payments) over the half trillion dollar mark. Consequently the United States needs high capital inflows to offset this huge deficit in current payments (and also to help finance the government's growing debt.)
Foreign investors are growing wary. According to Dr. Rob Van de Wijngaert, a strategist at ABN AMRO in Amsterdam, U.S. Treasury numbers show that "apparently there is not a single institutional fund in Japan which is willing to buy U.S. Treasuries and instead the Bank of Japan purchased no less that $150bn this year" According to Van de Wijngaert, the latest numbers show that foreign "demand for U.S. Treasuries, bonds and stocks is plummeting."
So why is it that yields on Treasuries and U.S. corporate bonds are still low while the U.S. stock market, as measured by the Dow, has done well this year and is making yet another attempt to climb over the 10,000 mark?
The reason is optimism and growth manufactured by astonishingly loose fiscal and monetary policy. Yes, throw away all budget restraint, throw credit at people and companies, throw away what we have learned about government spending and the economy since the 1960s, and you can create economic growth and rising markets -- for a while.
But even U.S. investors are getting nervous and ready to cash in while the going's still good. Insider trading --purchases and sales of shares by executives of their own company's shares -- showed a huge sell balance in November, according to Thomson financial, of almost $43 in stock sold for every $1 purchased. Executives sold $4.5 billion of their own companies' shares, the highest level of sales for more than two years.
It is another pointer. While Europe fails to excel, even if it is at last contemplating reform, the U.S. economy and U.S. markets are on an utterly unsustainable hare-like sprint along the road to a cliff. The plunging dollar shows where U.S. assets are going to head.
Global View is a weekly column giving a personal view of issues of importance for the global economy. Comments to icampbellupi.com.
