Level reached. Jean-Claude Juncker, President of the Eurogroup, indicated before the summer vacation that developments in the euro/dollar exchange rate would not be a cause for concern as long as it did not pass the threshold of 1.40 dollars to the euro. Now we are there, and the Eurogroup will take up this point at the beginning of next week in Luxembourg. We should not expect spectacular initiatives, but a declaration is likely. The European commissioner for economic and monetary affairs, Joaquin Almunia, in the interview which was partially covered in our bulletin 9513, did not announce any specific initiatives concerning the dollar, but he stated that the EU would not submit to global monetary disarray without reaction. The American authorities continue to repeat that they have no interest in a weak dollar; Mr Almunia would like to see “a bit of consistency between words and actions”. He added that the Chinese authorities are aware of European concerns about their management of their currency; they must strengthen their system of controls, which is not sufficiently flexible.
The ambition is always the same: to combat exchange rate instability. How? The independence of the European Central Bank is not in question, but dialogue with it is natural, the commissioner observed, stressing the one absolute condition: “It is obvious that if we want to be heard by the ECB, we must speak with a single voice and in a disciplined manner”.
The USA will not defend the dollar's parity. Basically, there is no miracle solution. Mr Almunia observed: “The economies of the euro area are not responsible for the situation. Unlike those of the USA and China, our balance of current transactions is balanced.” This is a polite way of saying that China should export less and import more, and that the USA should import less. But who is prepared to reduce their exports to the US market? Nobody (understandably enough). But in the absence of a reduction of the US deficit, how can the dollar regain its value? If China demanded the repayment of the American treasury bonds which it holds, the dollar would collapse immediately. Neither China nor the other countries which hold surprising levels of dollar reserves will do so, as this would go against their own interests, causing the value of their own monetary reserves which they have spent years accumulating to plummet. This is how we should interpret the famous words of a former Fed Chairman: “The dollar isn't our problem, it's yours.”
We should not be under any illusions: the USA will not defend the parity of their currency, they will let the market decide, in the knowledge that those sitting on heaps of it will not be quick to abandon it.
The “sovereign funds” puzzle. The considerations above lead automatically to the issue of sovereign funds, that is funds controlled by states: China first and foremost, but also Russia, several Gulf countries and global financial centres. I refer to the words of Mr Almunia: “These funds are becoming very powerful. The value of their assets, already twice that of hedge funds, could increase four or five-fold in the coming years. While avoiding any kind of protectionism, we should demand more transparency from the governments controlling these funds. We are within our rights to ask them what assets they want to invest in, and how many.”
The problems dovetail. We can see, therefore, how these problems dovetail: the euro exchange rate is linked to the development of the USA and China's trade balances; that development determines the volume of “sovereign funds” which are inflated to sometimes monstrous proportions because of the American trade deficit (in the case of China) or the sale of oil and gas, priced in dollars (in the case of Russia, the Gulf countries and others).
The attitude of simply demanding that the ECB reduce its interest rates is simplistic, not to mention naive; even Mr Sarkozy ought to agree on that when the time comes. Many other reforms and initiative are crucial, both at European and global level, to do with the functioning of the international financial markets, trade and action in Europe.
Tomorrow I will talk about three areas which I believe are seeing developments: a) control of financial markets; b) strengthening of the Eurogroup; c) the turning point in some Chinese exports. There are any number of elements which are worth a mention.
(F.R.)