IT’S D-DAY in Europe again–“D” as in “dollar and in “deflation.” This time it isn’t American bombs that are falling with ruinous effect, but the American dollar. Some attribute this new onslaught on Europe’s well being to the Bush administration’s public abandonment of the “strong dollar” policy that was former Treasury secretary Robert Rubin’s contribution to Clintonomics. Economists know better. It is economic fundamentals that determine exchange rates, and neither interventions by central bankers nor speeches by politicians can indefinitely and costlessly prevent currencies from realigning in response to those fundamentals. So much for those who see in the dollar’s decline a Bush administration plot to retaliate against France and Germany for their U.N. antics by unleashing the dogs of economic war. The White House has insufficient power over exchange rates to claim credit for those countries’ plight. That credit must go to the European Central bank and the French and German governments.
The ECB has stubbornly refused to lower interest rates sufficiently to accommodate the needs of Europe’s largest slumping economies. And now it is too late. Experts estimate that the recent rise in the euro has a growth-stifling impact equivalent to a two-percentage-point rise in interest rates. Since the Bank has cut rates by only a 0.75 percentage point until now, it would have to lower them by 1.25 percentage points more from the current level of 2.5 percent when it meets next month to offset the dollar’s plunge.
