Change intra-EU trade to counter US currency aggression

The writer is a senior fellow at the Hoover Institution, Stanford University

A rising euro and a weak economy is what European Central Bank president Christine Lagarde will have on her plate at the bank’s meeting this month.

US president Donald Trump and Federal Reserve chairman Jay Powell are trying to get the dollar down to bolster US economic fortunes, and Ms Lagarde will have to buy eurozone sovereign bonds to counter that and take the euro lower. Otherwise, a continuously rising euro will make the European economy even weaker.

But there may be a better way for Europe to thwart the US and any other “currency warriors”. One possibility, for example, is to restructure overall trade relations within the eurozone in a way that makes exports less dependent on the level of the euro, while also boosting overall eurozone growth — especially in the south, where economies are weaker.

This could be done, for example, if a southern country like Italy were to increase its exports to northern eurozone countries such as Germany, France and the Netherlands — at the expense of export destinations outside the eurozone such as the US. This would require that the northern countries change their economic strategies from export promotion to stimulate domestic aggregate demand instead. This would be a smart move in itself, given that the free trade global consensus has fallen apart during the Trump era.

In fact, taking advantage of the bloc’s huge internal market is Europe’s growth strategy for the future. Were the north to boost aggregate demand through, say, fiscal policy and budget deficits or increased wages, the demand for southern exports in the north should increase and the level of the euro would become less relevant for southern exporters. Of course, for structural trade reform like this to work, the supply side in the south must also produce attractive products for the north to buy.

One member of the ECB’s governing council to focus on such a response to the issue is Klaas Knot, president of the Dutch central bank. Instead of looking solely to ECB action — and the risks that emanate from having ultra-low interest rates — Mr Knot has advocated higher wages for Dutch workers, arguing that wage increases would create more intra-European trade integration, helping Europe protect itself from US beggar-my-neighbour monetary policies.

Beggar-my-neighbour monetary attacks from the US are, of course, not new. The rising euro, alongside the eurozone bond crisis, was one of the reasons why former ECB president Mario Draghi adopted the asset purchase programme — otherwise known as quantitative easing — in 2014. For Mr Draghi at the time, it was either European QE to keep the euro down in the face of US QE, or Europe was going to split because of a soaring euro that was out of line with the weak eurozone economy. Southern countries, with their high sovereign bond spreads and low growth economies, could not take much more of it.

Ms Lagarde is facing analogous problems. The currency pressure emanating from the US will not end even if Mr Trump is defeated. Indeed, it could become more intense if the Federal Reserve tries to make up for an expected rollback in tax cuts by Joe Biden, re-regulation of business and new social charges. Many on Wall Street believe the dollar will hit new lows with Mr Biden.

Ms Lagarde is in a tight spot, having to deal with a continuing round of US currency aggression and the second wave of Covid-19. Deflation adds to the pressures she faces. Although a new ECB research report claims that its bond buying has been effective in keeping the euro down, trade reform is a promising alternative strategy. By loosening the link between the euro and exports, it would have the added advantage of removing an important weapon from the hands of the euro’s enemies.

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