The Real War: the Euro and the Dollar

Many fingers will be pointing towards China this weekend. It’s clear that the global machine of currencies is no longer running smoothly when the Brazilian Minister of Finances and the head of the IMF both speak of currency wars, so Chinese exchange policies will be questioned at the International Monetary Fund’s meeting and the G7 summit in Washington.

The Americans, less than one month from a crucial election, see an easy target, and Europe follows right along. But the real problem does not lie there. First, the yuan is not completely undervalued. According to some measures, it would only drop 10 to 20 percent compared to the dollar, taking into account China’s status as a developing nation. Second, a higher-value yuan would not fundamentally change the system. From 2005 to 2008, the yuan rose by 20 percent without affecting any power relations in the competitive market. The only real effect was the higher cost of products that American and European businesses had manufactured there as opposed to those assembled around the world.

No, the real monetary problem stands between the two foremost world currencies: the dollar and the euro. Their exchange had been left to the free market since the birth of the latter in 1999, except when it hit rock bottom in 2000. However, in an economic crisis where we’ve “tried everything” except devaluation, this setup could easily change. The United States’ reaction in such a case would be relatively simple (even if it is naive to believe that America constantly manipulates its rate of exchange, as this variable is usually considered as secondary in a country less open than Europe). The head of the Federal Reserve, Ben Bernanke, has been considering this for a while.

The Fed is less independent than its counterpart, the European Central Bank. This is true in theory, by a law, instead of by a treaty ratified by 27 countries in order to withdraw its autonomy. This is also true in practice; the Fed bought the American Treasury’s bonds by the hundreds of billions without batting an eye while the ECB has only resolved to take on some of Greece’s bonds in the most extreme of circumstances. Yet, as the minting machine runs, it weakens the bills it prints. At the end of the day, the dollar has a Treasury to follow while the euro doesn’t even have a telephone number to call. Investors can feel the American potential just as acutely as the European weakness. That is one of the reasons why, for the first time in eight months, the euro was valued at more than 1.40 dollars yesterday.