Speak No Evil

Two days before European Central Bank president Wim Duisenberg was to speak at a gala dinner marking the 10th anniversary of the Amsterdam Institute of Finance earlier this month, the event's organizers were taken aback by a firmly worded e-mail from his office announcing an important schedule change: the president would not be taking questions from the audience. Duisenberg limited his utterances to a careful speech in which he did not even mention the euro's weak point: its anemic exchange rate, down more than 25% against the dollar since its launch on Jan. 1, 1999.

His reticence was understandable. In a now notorious October interview with the Times of London, Duisenberg had indicated that the E.C.B. would not intervene to support the euro if war broke out in the Middle East. Currency markets divined in that a general weakening in the bank's will to uphold the euro's value, and traders sold off the currency with gusto, resulting in a further drop in its value against the dollar to an all-time low of $0.8328. As French and Italian politicians openly voiced their outrage, the E.C.B. was forced into the ignominious position of having to dismiss as "absolute nonsense" rumors that Duisenberg was about to resign.

The E.C.B. president appears determined to hold to his rueful promise in the wake of that interview to stop talking about intervention altogether. That can only be salutory. But larger forces than mere ill-chosen words are at work in pushing the euro down. Once the words stop and the E.C.B. gets a surer feel for the mechanics of intervention and money supply perhaps the bigger story will get higher billing: the euro is in large part a victim of its own success. It has allowed scores of European companies not only to assess more accurately their own value and that of their competitors elsewhere in Europe, but also to embark on global ventures that would have been much harder to finance in Spanish pesetas, Austrian schillings or Belgian francs. By jump-starting the creation of Europe-wide bond and equity markets, it has helped fund an unprecedented flow of European capital to the United States.

In the 18 months following the January 1999 launch of the euro, the net outflow of capital from Euroland to the U.S. amounted to $253 billion more than double the amount of the previous 18 months. That massive flow of European investment to the U.S. amounts to 4% of the region's gross domestic product. It is possible that even a perfectly controlled E.C.B., headed by a Delphic master the likes of Federal Reserve chairman Alan Greenspan, would be hard pressed to uphold the euro's value in the face of that hemorrhage. If the situation were reversed and American investors were throwing money into the eurozone at that rate, that inflow would do a lot more to bolster the euro than any E.C.B. intervention on currency markets. For the fact is that capital's westward flow these days has little to do with the E.C.B. and a lot to do with economic policies of the member states.

As it is, the imperfect E.C.B. and its loquacious president serve as convenient scapegoats for European politicians who have yet to grasp the nettle and push through deeper reforms of their own economies. While the E.C.B. has damaged its cause by sending out conflicting messages, says Gary Dugan, global equity markets strategist with J.P. Morgan in London, it also has the misfortune of inhabiting "an environment where politicians have continued to push the 'self-destruct' button by keeping the rigidity in the labor market, which runs counter to anything helpful to the currency."

The eurozone also had the misfortune of being born in a period of miraculous growth in the U.S., creating an immensely appealing pull factor for European capital. "Of late it's been growth and earnings expectations which have been the main drivers of capital flows, and that's why so much Euroland capital has come to the U.S.," says Matthew Higgins, an international economist with Merrill Lynch in New York. "Growth and corporate earnings expectations have been stronger here."

Before the euro, it was much harder for European companies to drum up the capital to buy in the U.S. In 1999, European firms raised $100 billion on local bond markets, three or four times as much as the year before, according to J.P. Morgan vice president Alfonso Prat-Gay. Dutch consumer goods giant Unilever tapped the eurobond market for $7 billion in October to finance its acquisition of U.S.-based Bestfoods. "Improved conditions in the European bond market, thanks to the euro, have made such moves possible," says chairman Antony Burgmans. Dutch office product manufacturer Buhrmann financed its recent purchase of Colorado-based office supplies distributor Corporate Express with high-yield dollar bonds. But as Buhrmann chief financial officer Floris Waller says, "The growing eurobond market has improved the climate for all European corporate issuers." MORE>>

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By JAMES GRAFF Brussels

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Alas, not for the euro itself. "The E.C.B. keeps on saying that the euro is undervalued for some fundamental reason," says Tony Norfield, global head of foreign exchange research at ABN AMRO in London. "However, the E.C.B.'s own data show precisely why the euro is low: because of the large amount of funds going out of Europe toward the U.S. and elsewhere."

European governments have not done all they could to provide an equally conducive environment for growth, one that might have kept that money at home. Labor market rigidities contribute to a eurozone unemployment rate of 9%, compared with only 3.9% in the U.S. Though Europe's jobless rate has fallen steadily since 1997, its nagging persistence not only reduces consumption in Europe, but also commits significant government resources to supporting and retraining the unemployed. European leaders pay lip service to the need to rein in high social and regulatory costs and bring taxes down, but action has been slower in coming.

It is beyond the E.C.B.'s brief to dictate economic policy, and you can only imagine the uproar if Duisenberg got much more explicit than noting the need to "address longer-term issues" and avoid "any loosening of fiscal policy." His relations with finance ministers aren't the best as matters stand. Given the immense prestige factor of the euro's dollar exchange rate, the E.C.B. has little choice but to continue trying to prop up the currency by way of market interventions.

Yet the success of such actions is far from clear. When it intervened on Sept. 22, with the support of other major central banks, the euro rallied. But less than three weeks later it plummeted after Duisenberg's interview. Several interventions the central bank undertook alone since then have stanched the decline, perhaps, but hardly engendered a recovery. Should the bank try harder? The answer depends on what you consider the fair value of the euro. The currency market itself has remained committed for months to a range in the mid-80s. The Paris-based Organization for Economic Cooperation and Development sets its purchasing power parity at $0.94, while others go as high as $1.17. The Economist's "Big Mac" index which charts currencies against the constant of that universally available commodity yields a value of $0.98.

"The E.C.B.'s committing a substantial amount to intervention over a long time could, I believe, bring about a reversal in the euro's fortunes," says Richard Portes, a professor of economics at London Business School. "It has ample reserves." But intervening and failing to move the currency much further undermines the E.C.B.'s already wasting authority and provides politicians with another excuse to pile on. "The problem is the lack of adequate structural reform in the euro area sufficient to make it attractive for investors to put money into it," insists ABN AMRO's Norfield. "The E.C.B. is letting politicians off the hook by getting involved with this kind of action."

The fundamentals that could end up speaking loudest in the next few months are American ones. As the U.S. boom settles, emphasis on some of that economy's shakier attributes its gargantuan current account deficit, for instance, and the high level of indebtedness of its corporations and consumers is likely to increase. If the E.C.B. manages to act and talk prudently, that could offer a short-term chance for the euro to appreciate. "It has to happen within 12 months," says J.P. Morgan's Dugan. "That's the window of opportunity where the U.S. economy will slow, because the current account deficit will struggle to be funded through flows of capital."

But Europe can certainly do better than standing idle while the American economy determines the euro's fate on the currency markets. The euro is currently trading in a moderate range. Back in 1985, an equivalent basket of its precursor currencies only cost $0.69; in 1979, it traded at more than $1.40. Those values are a reminder of just how much cooler a view can be taken of the euro's current travails. The advantages the new currency has wrought for European businesses that can now market, merge and raise funds in a single currency will only increase as the euro moves toward coins and bills in early 2002. If Europe's politicians would build on those advantages with deeper economic reforms, the E.C.B.'s job would be much easier. And maybe Duisenberg could get back to the kind of jawing with the press that he clearly enjoyed in the past though he'd be wise to do so with considerably more care.

With reporting by Andrew Rosenbaum / Amsterdam and Christine Whitehouse / London