Francis Lambert
23/04/2010
The euro is the only current alternative to the US dollar as world reserve currency. Being sole reserve currency really helps when you need to sell mountains of bonds. Given the amount of debt the US must sell over the coming years, why encourage the competition, especially if its unclear that contagion can be avoided anyway?
Also, as anyone familiar with forex markets knows, the EUR/USD pair alone accounts for about a third of all forex trade. That means that for every 3 euros bought or sold, a USD is used. Thus the two push each other in opposite directions. As the EUR falls, the USD gets a huge boost and vice versa. A falling EUR means more USD demand, and lower US borrowing costs. That helps the US recover.
A falling euro also helps keeps US mortgage rates low as investors buy dollars and T bonds in a flight to safety, and that is a VERY big deal, given that starting July the US sees a wave of resets of a magnitude not seen since the wave that created the subprime crisis, which of course metastasized into the current Great Recession.
As noted above, if Washington needs to sell more bonds to pay for another bailout, the increased demand from a full blown crisis in the EU would not be the worst thing imaginable.
Conclusion: What Washington Must Weigh.
In sum, against the risk of EU implosion and contraction under the weight of a wave of PIIGS state defaults (as one default sends borrowing rates for all to unaffordable levels), and possible global sovereign and banking default contagion, the US must weigh:
Contagion and crash part II may be unavoidable anyway, so best to face it without another layer of deficit spending
Near term benefits of a flight to safety that bolsters the USD and lowers US borrowing costs (though there is real risk that all sovereign states may see higher rates)
Longer term benefits of a much weakened euro eliminated as competition for reserve currency status. Yes, a cheaper euro makes US goods more expensive, but given US borrowing needs and impending mortgage rate resets, keeping US borrowing costs lower is arguably the greater near term economic and political priority.
Key point despite what markets currently think, its really uncertain that the EU can be saved, whereas the above advantages of keeping the US purse shut are fairly clear.
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