Jean-Claude Trichet, president of the European Central Bank (ECB), is complaining about "brutal" and "unwelcome" gains in the euro. But as President Chirac knows, French objections about American aggression carry little weight in Washington.
However, the currency war is not simply transatlantic. It's global so long as Asia continues to dodge the deflationary bullet by intervening to resist the strengthening of its currencies. US policy-makers probably see this as a "win-win" situation. Either US growth will benefit from the competitiveness gains arising from dollar weakness, or foreign central bank intervention will stem the tide, so providing a ready source of funding for the US deficits and capping a growth-threatening rise in bond yields.
But policy-makers are playing a dangerous game in encouraging the belief that a weaker dollar is inevitable if the US current account deficit is to be reduced. Outside economists, of course, have been warning of this for years. But when the Federal Reserve chairman endorses this line of thinking, it converts it in the market's mind from a theoretical musing into an officially tolerated objective.
The sheer scale of the required adjustment is in itself one reason to doubt whether the decline in the US dollar will be "orderly". After all, if everyone suddenly came round to the view that the dollar will have to fall, say, a further 20 per cent over the next two years, the fall would happen immediately.
The absence of co-ordinated policy responses makes the risk of a dollar crash all the greater. The Bush administration's plans to cut the budget deficit rely on keeping the US economy growing strongly enough to boost tax revenue. But this approach may simply replace government with private sector borrowing, so that the current account deficit fails to fall. Yet while the US resists foreign pleas to cut its demand, the rest of the world is unable or unwilling to respond to US pleas to help curb its deficit by boosting their demand.
This leaves a weaker dollar as the only other adjustment option. However, with Asia and Europe relying on exports for growth, their tolerance for this is also limited. Asia has resisted currency appreciation over the past two years, even though it is responsible for much more of the US trade deficit than is Europe; this is upsetting European policy-makers, who have so far forsworn intervention. The euro's sharper rise has exacted a heavy toll on European growth. Central banks in Asia and elsewhere are switching their reserves out of dollars into euros, adding to the upward pressure on the euro.
Having seen the euro soar by 10 per cent against the dollar over the past three months, the ECB will surely be contemplating "turning Japanese", ie intervening unilaterally and aggressively. If the ECB intervenes, its success and credibility will dictate that it does so on a large scale, and it will want to use the element of surprise to "burn" speculators. This means that second guessing the level at which it will intervene, or the timing, is tough. One report suggested $1.35 might be the key level, but a successful defence would imply stepping in some way below it - perhaps closer to $1.40.
US support would add greatly to the credibility of the ECB's intervention, even if the Fed has only $41bn (£21bn) of reserves to play with. The problem is how to persuade the US that this is in its interests. It may need signs that the dollar's decline is turning sufficiently disorderly to upset asset markets. The talk of open policy conflict that unilateral ECB intervention might prompt could do the trick. After all, 1987's policy fight with the US led to the stock market crash.
Mark Cliffe is chief economist at ING Financial Markets
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