The US dollar surprised many people by retaining its value for a long period during this economic crisis. Despite, 0% interest rates, increasing government debt, and a current account deficit, many were still buying the dollar as it was perceived as ‘relatively safe’
However, the recent plan by US treasury to buy even more assets (not certain how this will be financed yet, but probably involve increasing money supply) has finally caused the dollar rally to end.
The policy of quantitative easing increases the inflationary risk of the dollar and so investors have been selling the dollar and looking for alternative ‘safe havens’.
The problem is that it is very difficult to pick out a safe haven in the current climate. Also becoming the world’s reserve currency could be highly undesirable given global downturn For example, recently the Swiss government took quick action to try and prevent the Swiss currency from becoming perceived as a safe haven. (Swiss take action to prevent rise of Swiss Franc)
Many are now pointing to the Euro as a safe haven currency. The ECB seem the most reluctant Central Bank to even discuss quantitative easing. They may be reluctant to effectively fight recession and deflation but above all else they are not going to risk inflation.
Whether the ECB approach is good for the EU economy is a matter of debate. But, this reluctance to increase money supply is likely to make the Euro more attractive.
However, if you look at:
- government borrowing levels in Europe,
- the EU trade deficit of 32 billion Euros,
- and the extent of the recession,
the Euro looks less appealing in the long term. Economists such as Milton Friedman even doubted whether the Euro could survive a recession at all.
The problem is becoming the world’s reserve currency could create further problems for the EU economy – already facing its worst downturn since the war. In many EU countries like Germany, exports play an important role in the economy. A strong Euro would make exporting even more difficult.
“If the euro keeps rising, it will be really grim news for the euro economy, which is already in very bad shape,” said Paul de Grauwe, a professor at the Catholic University of Leuven in Belgium.
Some predict the Euro could breach $1.60 within a few months. This would be devastating for EU exporters already struggling from effects of global downturn.