The Paradox of the Euro: Standing Strong Amid Crisis and Fear and Winning the Currency War

Last Wednesday, near the big Tehran bazaar, tens of thousands of merchants protested against the government of Mahmoud Ahmadinejad and the swift devaluation of the rial, the Iranian currency that since the start of the year, by way of international sanctions, has lost two thirds of its value compared with the dollar, one third in the last week. Meanwhile, the Turkish lira is significantly weakened by the start of Ankara’s military retaliation against Syrian President Bashar al-Assad’s regime. And even the Australian dollar has slid after the Reserve Bank’s decision to cut interest rates in order to combat the impact that the decrease in commodity prices is having on the recovery. The fate of the finances of the three countries — Iran, Turkey, Australia — reminds us of how sensitive and unpredictable the Forex — the global currency market — is, where every day, among spot, swap and option transactions, more than $4 billion dollars are exchanged. Yet still, for many months, this immense market has seemed almost paralyzed by the uncertainties of the future and by doubts regarding the principal currencies, starting with the dollar and the euro.

Last year, Wall Street was convinced that the reduction of the U.S.’ rating by Standard and Poor’s would lead to a noticeable — perhaps historic — downturn of the dollar, adding to the grave deficit problems and to the injections of liquidity on the part of the Federal Reserve by Ben Bernanke. In the eyes of many, the greenback still appears weak today, and it is certainly stimulating exports made in the U.S. and impeding those of Brazil, South Korea and Indonesia, who have protested a number of times. And yet, the index of the value of the dollar, measured by the Federal Reserve in St. Louis, shows that since March 2008 — that is, since Bear Stearns’ exit from the stage — until last week, the American currency has remained more or less stationary, and if anything a bit stronger (+3 percent).

Even for the euro, the experts predicted a downturn. How could it not feel shockwaves from the Greek instability, the Spanish accounts situation, the general drop in gross domestic product, the initiatives of the European Central Bank’s Mario Draghi, the centripetal forces in the eurozone and even after many announcements of its early demise? But the European currency continues to resist the expected catastrophes. Last Thursday, it was enough that Draghi and his colleagues reaffirmed the “irreversibility” of the economic union and left interest rates stable, to lead to a strengthening of the common currency.

But the calm in the markets could soon break: At least, this is the impression of a growing number of American operators and analysts, consulted on the medium-term destinies of the dollar and the euro. “… The U.S. currency will take off … [as] recent data suggest that the current upturn has more traction,” explains Nicholas Hastings of the Dow Jones Newswires, which for 20 years has followed the fate of the exchange. Hastings’ reasoning is simple. Until now, the American recovery was anything but certain. The Fed’s attempts to increase the liquidity of the system, to anti-recessive ends, with the injection of over $2 trillion dollars through the operations QE1 and QE2 — that is, the first two rounds of quantitative easing — to which they are about to add as much with the announced QE3, have had repercussions on the dollar.

But the climate is changing. A growing number of economic indicators point to a net improvement after five years of crisis. The real estate market, which is what triggered the financial storm, is at a turning point. In August, the average price of American houses rose by 4.6 percent compared to the same month in the previous year. Also in August, the sales of already existing houses rose by 7.8 percent. Loan requests went up at the end of September by 16.6 percent. Meanwhile, car sales in the U.S. have returned to pre-Lehman Brothers rhythms — 14.9 million vehicles a year — and Mark Zanda [Zandi], chief economist at Moody’s, talks of [how] “the auto industry came close to death’s door,” whereas by now it is “competitive [and] has contributed to the strength of the recovery.” “… A shift in expectations …,” maintains Hastings, “… makes the dollar even more attractive to investors …” Not only because sooner or later the Fed will have to set up a credit freeze to avoid the risk of inflation, thus offering higher and more affordable rates, but above all because the U.S. economy appears on the launching pad “while the other economies are not doing a stroke of work.”*

And to complete the square is Romney’s victory in the televised duel with Obama. It is no mystery that the Republican candidate is against every tax increase to stabilize the public downturn and is greatly preferred by Wall Street and by global investors.

The emergence of this new optimism regarding the short-term potential of the dollar does not manage, however, to explain the high quotes of gold or, especially, to dispel the long-held worries about the American currency. The yellow metal was exchanged last week for $1,783 dollars an ounce, close to the 2012 record of $1,791. With respect to the euro, gold has reached a historic record — 1,380. Why? How does one explain that in recent weeks investors have bought $1 billion of financial products linked to gold? And why are the exchange-traded gold funds, like the SPDR Gold Shares, which are the largest, registering consistent quarterly increases?

The impression is that the steep rise is linked to inflationary fears. The stimulus actions launched now by all the central banks could lead to an overheating of the economy. Of course, the level of prices is still under control, and there is no glimpse of a dangerous spiral, at least for the moment. But it is clear that the situation will change in the coming years, and perhaps even earlier than expected, if the American economy should begin to pull itself up in earnest.

On the other hand, how long will the monopoly of the dollar be able to last? For how long yet will China be content to raise its reserves of greenbacks ($3.2 trillion dollars) without protesting? Former U.S. Secretary of the Treasury, John Connolly, once said that “[t]he dollar is our currency but your problem” — a phrase that became immediately famous — as if to say that it is the other countries, not the U.S., that have to reckon with the supremacy of the American dollar. But Beijing shows signs of impatience, which became clear last week at a successful conference hosted by London’s International Institute for Strategic Studies, in Bahrain. And China is already quietly launching a series of initiatives to favor exchanges with its currency, the yuan, with the object of arriving at an international monetary system based on three currencies — dollar, euro, yuan — and not only on the greenback.

*Editor’s note: This quote could not be sourced, as the author did not attribute it to anyone.