Watching euro is like watching British tennis

In some parts of the US they are now talking about Europe as the next "failed state". Of course, that is more an economic than a political judgment (although attitudes towards France are, if anything, hardening). Chris Johns explains.

While not a mainstream view, the idea that Europe (and Japan) is no longer interested in economic growth provides a neat explanation of just why many in the US are more than happy to see the dollar decline. And why that fall may have a lot further to go.

Most European economists look at the US and see lots of "imbalances" that need to be cured. Most obviously, there is a huge balance of payments deficit that is eliminated, according to orthodox analysis, by a combination of a weaker dollar and a slowdown in US (relative) economic growth.

Some US analysts completely reject this conventional prescription and argue that the problem lies entirely with the rest of the world.

In particular, they focus on the desire of overseas investors for US assets. This generates a significant capital account deficit in places like Europe and Japan (money flows from those regions into US equities, bonds and other assets).

In this model, the US acts like a central banker to the world, supplying dollars to those countries that need them to buy those US assets. The way these things work the only mechanism for meeting that demand for dollars is for the US to run a current account deficit.

Hence, the problem is turned on its head. In the US, the imbalances are seen as the fault of the Europeans (and others). Elsewhere, US deficits are US deficits and their resolution is entirely the responsibility of George Bush and Alan Greenspan.

This dialogue of the deaf is listened to most keenly by the foreign exchange markets. They see a US administration desperate to push every economic policy button marked "reflation". Interest rates are at historic lows and likely to fall further, the Federal Reserve is toying with the idea of printing money. The president is pushing for more tax cuts.

It isn't too difficult to spot that a lower dollar is a logical part of this process, particularly with the Fed beginning to fret even more about the threat of deflation.

The US administration pays lip service to the old "strong dollar" mantra but, in the same breath, gives the game away by pointing out that US exports get a boost from a weaker currency. The implicit message is clear: Wim Duisenberg, the president of the European Central Bank, keeps saying that a strong euro is welcome. If that is what he believes, that is what he will get. If Europe wants a strong currency, the US is more than happy to deliver. Privately, Americans think this is Alice in Wonderland stuff, and that European economic policy is verging on the demented.

In the old days, all of this would be resolved at a G7 meeting where like-minded finance ministers and central bankers would resolve their difference and agree a common approach towards exchange rates and other matters of international finance. Where disagreements could not be resolved they would be brushed under the carpet and important sounding communiqués would suggest a united front. Of course, we no longer have quite so many "like-minded" policy-makers.

The markets are pushing the euro up because they see a classic one-way bet. The US sees a weaker dollar as a good thing and the Europeans, bizarrely, seem also to welcome it. Until something changes this perception, the euro will stay strong.

Meanwhile, the European economy - which has to operate in the real world - is reeling from the effects of a major currency appreciation. This has come at a time when growth was not exactly firing on all cylinders. Export orders are collapsing and there are few signs of a post-war bounce in confidence indicators. Somebody in Frankfurt and Brussels will notice eventually.

Here in the UK, all of this flies over the heads of the shrinking number of people interested enough to continue debating the merits of euro entry. It's a bit like watching the British obsession with Wimbledon. They dream of playing on the centre court but rarely make it beyond the first few rounds.

But tennis is a game that has become as dull as the euro debate and I wonder why we stay so interested given that we are so obviously unsuited to either sport. Sterling has just experienced one of the quietest devaluations in history and we will walk away with unintended victory. I can hear Tony Blair's speech-writers trying to figure out how he can claim the credit.

Chris Johns is chief strategist ABN AMRO Securities, London. All opinions expressed are entirely personal.

cjohns@eircom.net