Euro’s Continued Slide to Record Low Baffles Many Economists

With Europe’s common currency, the euro, in the macroeconomic version of free fall, central bankers Thursday ordered the third interest rate hike this year. The euro’s response: It kept dropping, hitting a record low close of 91 cents against the U.S. dollar.

Since its creation in January 1999, the currency shared by 11 European Union countries has lost more than 21% of its value relative to the greenback. The continuing shrinkage has increasingly flummoxed many economists, who admit to being at a loss for an explanation.

“I know this isn’t a satisfactory answer, but it’s a mystery,” Joachim Scheide, head of the business cycles department at the Kiel Institute of World Economics in Germany, said in an interview. “As economists, we must admit that it is hard to explain exchange rates, let alone predict them.”

Perversely, the euro’s collapse coincides with a strengthening of the economies of the Western European countries that use it. Growth has been accelerating significantly since mid-1999 and is forecast to reach 3.4% this year.

It’s not just that the dollar and the powerful U.S. economy are hotter than Europe and the euro. The European currency also has been plummeting relative to the Japanese yen and the British pound.

Meeting in Frankfurt, Germany, the leaders of the European Central Bank, the euro zone’s beleaguered equivalent of the Federal Reserve, decided on a quarter-percentage-point hike in the bank’s main interest rate, to 3.75%.

Beforehand, analysts had openly doubted the ECB’s power to arrest the euro’s slide. On Tuesday and Wednesday, the currency had dropped precipitously, then firmed to the equivalent of 92 U.S. cents. In New York trading Thursday, after the ECB meeting, it lost another penny.

In theory, making the cost of borrowing money more expensive should shore up a currency’s value.

Analysts said the reaction of traders showed the low stock they put in the ECB and its ability to set firm and coherent policy.

“The markets think, ‘Why don’t they [the ECB] know what to do?’ ” Scheide said. “It’s unclear to the markets what the ECB stands for in relation to exchange-rate policy.”

Member governments have hardly helped. At the same time that German Finance Minister Hans Eichel was recently demanding a “strong euro,” France’s secretary of state for industry, Christian Pierret, was calling the euro’s drop in value “not a bad thing.”

Increasingly wary, investors have been voting against the new European money, leading to an exodus of long-term capital. The net outflow of direct investment capital from the euro zone last year totaled $135 billion, slowing Europe’s economic revival, according to the London-based Financial Times.

After the ECB’s latest announcement of a rate hike, the euro also sagged against the British currency, from 0.5863 to 0.5822 pounds, and against the Japanese currency, from 98.15 to 97.54 yen.

For the euro-zone nations--Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain--a weak euro means their exports are priced cheaper in world markets and are more competitive. It is also good news for American tourists, whose dollar goes 28% further in Paris, Rome and the rest of the euro area than at the beginning of last year.

However, Americans who own investments in euro countries, such as stock in international mutual funds, have seen their returns eroded or canceled by the shrinking currency.

For Europeans, the downside of the ongoing trend is that they need more euros to purchase imports, including raw materials such as petroleum that are traditionally priced in dollars. While world oil prices were surging, for example, gasoline prices for Europeans leaped an extra 21% because of the euro’s weakness.

That eats into consumers’ purchasing power, fuels inflation and has caused the public in countries such as Germany--which boasts the euro zone’s biggest economy--increasingly to question the wisdom of using the shared currency.

On Wednesday, German Chancellor Gerhard Schroeder expressed befuddlement that the euro was so little prized on world markets, considering Europe’s economic fundamentals. “The figures are so sparkling I have no fear for the euro,” the German leader said. “Europe is in good form at the moment.”

For some analysts, however, the euro’s woes are a symptom of deep-seated problems in the economies of Western Europe, including government over-regulation and the slow pace of reform in labor markets, tax systems and social security. These policies are not set by ECB President Wim Duisenberg and his colleagues, but by member governments. France and Italy are considered among the most notorious laggards.

“If we fail to crack those tough nuts, we will not come to grips with the euro’s external value,” Franz-Christoph Zeitler, a member of the German Bundesbank’s council, warned this week.

The ECB last raised interest rates March 16, also by a quarter of a point. Until Jan. 1, 2002, when euro coins and bank notes are to come into being, the currency exists chiefly as an accounting unit to denominate noncash transactions, such as the buying and selling of government bonds.

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France on Sale?

As the euro continues to sink in value against the U.S. dollar, so do the currencies of the 11 euro member nations. The flip side is that the dollar’s purchasing power in those nations is the highest since the mid-1980s. What the dollar buys in French francs, quarterly data and latest:

1986: 7.20 francs

Thursday: 7.20 francs

Dollar vs. Key Currencies

Although the dollar’s value has surged about 28% against the euro and its member currencies since Jan. 1, 1999, the buck buys less today in Japan, Canada and Mexico, among other non-euro nations. What $1 bought in key currencies in 1999 and what it buys now:

Major euro nations

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Country/currency Jan. 1, 1999 Thursday Germany (mark) 1.68 2.15 Ireland (punt) 0.68 0.87 Italy (lira) 1,661.00 2,126.00 Netherlands (guilder) 1.88 2.42 Spain (peseta) 143.00 183.00 Euro 0.85 1.09

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Non-euro nations

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Country/currency Jan. 1, 1999 Thursday Britain (pound) 0.60 0.64 Japan (yen) 115.00 106.00 Canada (dollar) 1.55 1.48 Mexico (peso) 9.94 9.43

*--*

Sources: Times research, Bloomberg News