The dollar is up against the euro. No, the dollar is down against the euro. Now it’s up again. Until it goes down.
Meteorologists have a term, the “Fujiwara effect,” to describe the interaction of two storms in close proximity. In the Northern hemisphere, wind blows counterclockwise around centres of low pressure. When two lows “dance the Fujiwara,” as some scientists put it, the winds of each storm influence the other, causing the lows to rotate counterclockwise around a central point. The storms keep their separate identities for a time, yet they become increasingly connected until, sometimes, they merge.
Europe and the United States each are dealing with their own economic storms, but they are not independent of one another. Global trade and international finance have pulled these two mighty economies so close together that neither travels an independent path.
So when the U.S. Federal Reserve moves to stimulate our economy with $600 billion in cash created out of thin air, it drives down the dollar’s value against the euro. That makes it more difficult for struggling European economies, like Greece and Portugal, to export goods or to attract tourists, which they are desperate to do in order to service their national debts.
The prospect of debt defaults in Greece, Portugal or fellow euro member Ireland then drives down the value of the euro. America consequently finds it more difficult to close its own trade deficit or stimulate its economy, so tax revenues languish and governments at all levels risk falling deeper into debt. This sets the stage for the next round of stimulus.
The United States and Europe are dancing the Fujiwara.
Our currencies have moved in wary circles around one another all year. We began 2010 with a weak dollar, as staggering U.S. budget deficits and a headlong rush toward expensive health care overhaul undermined faith in American fiscal management.
Then the Greek debt crisis came along in the spring. The euro fell; the dollar rallied. Things calmed down only after European leaders cobbled together a massive bailout fund for Greece and other weakened countries on the continent’s periphery.
By late summer, the U.S. central bank was worried about deflation and a weak economic recovery. It began hinting at plans to launch a new round of “quantitative easing” to flood the economy with money. After this month’s elections, the plan was announced: $600 billion of new cash to be created by central bank fiat in the next eight months. The dollar fell; the euro rallied.
But not for long. Attention shifted to Ireland, which saw its borrowing rates go through the roof as it struggled with a 50-billion-euro bailout of its decrepit banks, and to Portugal, whose government budget is also deep in the red. German Chancellor Angela Merkel threw the credit markets into a panic when she suggested that euro nations’ bond holders would have to take a financial hit to get those countries’ financial houses in order. In other words, she said that German taxpayers are not going to be the only ones on the hook to bail out those Europeans who share their currency but not their financial discipline.
Naturally, the prospect of losing money on Irish, Greek and Portuguese bonds is not appealing to potential investors. The weak nations’ bonds sank and their borrowing costs soared. European leaders scrambled last week to promise that any bondholder “haircuts” would only apply after 2013, not now. This did not reassure bond investors.
So we were back to crisis mode in Europe, with a rising possibility that some countries might abandon the euro, which sank again. It may reverse course again, though, following yesterday’s announcement that Ireland will accept eurozone financial backing.
Meanwhile, away from the dance floor, the great Atlantic economic storm is doing damage all over the world. Governments from Canada to Japan to Brazil are struggling to keep their own currencies from soaring as traders avoid both the dollar and the euro. China, which ties its currency to the dollar, is trying to contain the inflation that comes from having to buy all sorts of imported raw materials with depreciating money.
The Fujiwara stops when the storms merge into one powerful tempest, or when one or both of the storms dissipate. This destabilizing global cycle, therefore, calls for effective policy action to calm the economic seas on each side of the Atlantic.
America and Europe got to roughly the same economic place by different routes. Our crisis was touched off by chronic trade and budget deficits, a housing boom fuelled by artificially cheap credit, and a crisis in the banking industry that began with sloppy lending, which fuelled much of the housing boom.
Europe’s crisis also has a banking connection, as bad American loans were sold to overseas buyers. But most of Europe’s problems are rooted in low European productivity, high taxes, inflexible labour markets and an ageing population in the productive northern European nations. The most troubled countries on the periphery of the euro zone made matters worse by having their governments run massive deficits — which in the case of Greece were hidden by misleading accounting — while relying on cheap credit that the euro made available.
The solutions will be similar. The troubled economies need greater productivity, more efficient and less expensive government, and a scaling back of social benefits that will be very difficult to accomplish politically. Conceivably, the United States could right itself even if Europe does not, or vice versa. But it would be much easier for both economies to recover if the other stopped creating a financial vortex.
The disagreements at the recent G-20 economic summit showed that governments increasingly find it difficult to agree on policies and to coordinate their actions. Leaders are more inclined to move independently, to protect their own currency and trade positions.
But their freedom of movement is limited. They probably don’t know it, since central bankers and heads of states usually are not meteorologists, but the Fujiwara effect has taken hold. The world’s troubled major economies will travel together, whether they want to or not.