Economists See Euro at $1.50 as US Trade Deficit Adjusts

July 22, 2003
By Elizabeth Price, Of DOW JONES NEWSWIRES

WASHINGTON (Dow Jones)--The euro will likely rise to about $1.50 once the U.S. current account deficit begins to adjust to a more sustainable level, Edwin Truman, a former U.S. Treasury and Federal Reserve official, said Tuesday.

Truman, now a scholar at the Institute for International Economics, estimated the effect of the stronger euro will cut Europe's economic growth rate by 1%-2% of gross domestic product. It is a prospect for which they are unprepared to cope, and have few options for softening the blow to the economy, he said.

"I would advocate prayer," Truman said taking part in a panel discussion on currency markets sponsored by the American Enterprise Institute.

The threat of abrupt currency realignments posed by the massive U.S. current account deficit makes the need for structural reforms in Europe and Japan all the more acute, said Truman and other economists.

From its peak, the U.S. dollar has depreciated about 16% against the euro to around $1.13, but only about half that much on a trade-weighted basis. Many economists warn this adjustment is not enough to put the U.S. current account deficit, a broad measure of international trade that includes goods, services and investment flows, on a sustainable footing.

Michael Rosenberg, currency strategist at Deutsche Bank, shared the view that the euro would eventually rise to roughly $1.40 to $1.50. He described the dollar's gains of the past few weeks as temporary, with a second period of dollar weakness to take off around the end of the summer. The yen, which the Japanese government has managed to hold stable against the dollar through heavy market intervention, will likely strengthen as well during this second wave of dollar weakness, he said.

"The lack of domestic demand (among U.S. trading partners) puts a higher burden of adjustment on the exchange rate and that is why I am a big bear on the dollar," Rosenberg said, noting that official flows, like purchases of U.S. Treasury bonds by foreign central banks, are accounting for a growing share of the U.S. current account deficit.

The U.S. deficit is now running at over 5% as a share of the U.S. economy and some predict it will rise as high as 7% next year, as U.S. demand continues to outpace that of the rest of the world. The fear is that foreigners may become unwilling to finance U.S. consumption and investment, leading to higher interest rates.

"History indicates it will reverse," said Kenneth Rogoff, the International Monetary Fund's chief economist. Further, a dramatic shift in the U.S. budget from surplus to mounting deficits heightens the risks, he said.

"The crux of it is there will be very large adjustments for the U.S. and the world," Rogoff said.

Given that Asia accounts for a 44% share of U.S. trade, the region's currencies won't escape some of the adjustment to a weaker dollar, Rosenberg said. Still, the euro-zone will bear a disproportionate share of the load, the economists agreed. This is in part because Asian governments manage their exchange rates through intervention. Calls for this practice to end have become a theme of European policymakers, worried that euro gains will smother their export industries. In the U.S. and Japan as well, manufacturers are demanding their governments pressure the Chinese to relax their currency peg and allow the yuan to appreciate.

That focus is misguided, said Bank of America Economist Mickey Levy.

"Core Europe's problems aren't the currency and it's not the ECB's monetary policy, although many of us believe the ECB will cut rates further," Levy said. "It is a host of fiscal and regulatory polices that are restraining growth."

Levy said the U.S. current account deficit grew so large, mostly because the U.S. has offered better investment prospects. "I am concerned that selected other countries have poor investment opportunities and they should implement measures that would make them a more desirable investment opportunity," he said.

Others argued a relaxation in China's currency peg wouldn't make much difference anyway. Vince Truglia, a senior sovereign analyst at Moody's Investors Service, pointed out that although China is growing very rapidly, the country saves almost half of its GDP. "How much more savings could China absorb? ," he asked.

Adam Posen, an economist at the Institute for International Economists, said that it is possible that Chinese investors, once freed from capital restrictions, might prefer to diversify out of Chinese assets. This could make the Chinese currency weaker, not stronger.

Finally, several economists said it is doubtful the Chinese currency would depreciate enough to offset the extremely low labor costs that make it so competitive.

-By Elizabeth Price, Dow Jones Newswires; 202-862-9295; Elizabeth.Price@dowjones.com
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