International Monetary Coordination - A Call for Unity Among Central Banks Worldwide
In a surprising turn of events, the US dollar has fallen by around 12 percent compared to the euro since the beginning of the year, defying conventional economic theories and standard expectations. This shift has significant implications for trade, investments, and economic relations between the United States and the European Union (EU).
The recently signed US-EU trade deal was expected to favor domestic production in the US and commit the EU to buy more energy and arms. However, the US dollar's decline has left many economists puzzled, as it should have strengthened due to the trade deal. But, as John Maynard Keynes noted in the 1930s, "as long as monetary chaos reigns, it's futile to negotiate about tariffs."
The divergence in exchange rates between the US dollar and euro is largely due to complex and evolving factors beyond simple trade deals and interest rate differentials. One key factor is the divergent monetary policies pursued by the US Federal Reserve and the European Central Bank (ECB). While the Fed has maintained a hawkish stance with higher interest rates, the ECB has pursued aggressive rate cuts and easing to stimulate growth. This creates a large yield gap favouring the US dollar, which tends to strengthen the dollar versus the euro.
However, other factors have worked against the US dollar. Rising US budget deficits, expansive fiscal spending proposals, and political interference in monetary policy have weakened confidence in the dollar and caused volatility. Market valuations and investor sentiment also fluctuate, with recent trends showing European equities outperforming US ones due partly to US tariff impacts and the US market’s high valuations, contributing to dollar weakness.
Internal Eurozone divides also play a role in the euro's value. Inflation rates and economic conditions vary widely between eurozone members, making the euro's value uneven. While the ECB’s accommodative policies generally weaken the euro, stronger fiscal countries like Germany support parts of the currency. This internal fragmentation adds complexity to exchange rate behavior.
US tariffs on EU goods reduce European exports' competitiveness, which would normally depreciate the euro; however, markets are also factoring in other global currency moves (e.g., devaluation of Asian currencies) and structural shifts in production, complicating the euro’s trajectory.
In light of these complexities, it's clear that exchange rate movements do not strictly follow textbook theory. Instead, exchange rates reflect a dynamic mix of policy divergence, geopolitical risks, fiscal imbalances, and investor risk appetite.
The wochenour website, a left-wing weekly newspaper, reports that financial markets are currently dominated by panic, speculation, and herd behavior, further contributing to the unpredictability of currency fluctuations.
Despite these challenges, central banks must cooperate to adjust exchange rates according to established rules and collectively defend the exchange rate on financial markets. The quote "Central banks of all countries, unite!" is often attributed to both Marx and Keynes, underscoring the importance of cooperation in navigating the complex world of currencies.
With the EU Commission President, Ursula von der Leyen, spending weeks negotiating with Trump to minimize tariffs on exports, there is hope that future trade agreements could help stabilize currency fluctuations. However, the current state of the US-EU economic relations and monetary policy suggests that any such agreement will need to account for the complex and evolving factors influencing exchange rates.
Maurice Höfgen, an author and economist who writes about economic utopias on the wochenour website, emphasizes the need for a more coordinated approach to manage currency fluctuations and promote economic stability. As the dance between the US dollar and euro continues, it's clear that understanding these complexities will be crucial for policymakers and investors alike.
The unanticipated drop in the US dollar's value against the euro, as evidenced by the 12 percent decrease since the beginning of the year, has baffled many economists, given the recently signed US-EU trade deal and conventional economic theories. This mysterious decline in the US dollar can be attributed to a multitude of factors, such as the divergent monetary policies pursued by the US Federal Reserve and the European Central Bank, rising US budget deficits, political interference in monetary policy, volatile investor sentiment, and the eurozone's internal divisions.
In attempts to preserve economic stability and curb currency fluctuations, as advocated by authors like Maurice Höfgen, central banks must cooperate to adjust exchange rates according to established rules and collectively defend the exchange rate on financial markets, emulating the sentiment embedded in the quote "Central banks of all countries, unite!"
