Bruised, battered, but so far unbowed. Europe's economies may be under threat from the "brutal" volatility of exchange rates - European Central Bank president Jean-Claude Trichet's way of expressing concern about the euro's strength - but Europe's policy-makers have so far done very little to deal with the problem. Verbal expressions of discomfort, perhaps, but no real action. It's a bit like having a tummy upset - you know that, in the end, something unpleasant is likely to emerge out of one end or the other, but you lie in bed, hoping and praying that, this time, you will be spared that horrible dash to the toilet.
Yet, funnily enough, once you've made that dash, and emptied your stomach's contents, you often tend to feel a whole lot fitter. Far better, then, to act than to ignore your discomfort. For the time being, though, Europe's policy makers have chosen not to act. And this lack of action will only make the economic stomach cramps even worse.
The decision to do nothing has been rationalised through some rather peculiar "doublespeak". The editorial writers of the European Central Bank's monthly report argue that, yes, the euro's strength will have a negative impact on the eurozone economy but that the situation need not be a disaster. Indeed, the ECB argues that, with the rest of the world now recovering strongly, eurozone exports will flourish even with the rise in the euro. Specifically, the ECB says that "although recent exchange rate developments are likely to have some dampening effects on exports, export growth should continue to benefit from the dynamic expansion of the world economy."
I know what they're getting at. For most countries, the level of demand in other parts of the world is a much more important influence on export performance than are exchange rate movements. But there are two reasons why this doesn't quite let the ECB off the hook. First, the ECB has been highly critical of policies followed in other parts of the world. For example, it has strongly criticised the Americans for their pursuit of low interest rates and loose fiscal policy against a background of a large and rapidly widening current account deficit. If the ECB is right - that this US approach is unsustainable - it's a bit rich for the ECB to then claim that European exports will benefit from dynamism elsewhere. This looks suspiciously like a classic free-rider problem: do nothing yourself, and benefit from - possibly wrong - policies pursued in other parts of the world.
Second, the eurozone's growth record in 2003 was disappointing both compared with consensus expectations at the beginning of last year and with the results seen elsewhere, particularly those recorded in the US and in Asia. Why the disappointment? One factor that surely played a role was exchange rate movements. The euro was far stronger than expected through the course of 2003, basically implying that the US and Asia benefited from a sustained improvement in competitiveness against Germany, France and the other members of Europe's single currency. In other words, it's slightly odd to argue that Europe will be absolutely fine because of the strong expansion taking place elsewhere when, in truth, that strong expansion has come at Europe's expense.
If anything, from Europe's point of view, this story is likely to get worse. The US may be growing strongly, but there's very little in the way of jobs growth. Jobs mean votes, so George Bush needs to get the labour market moving. Dollar depreciation is one way of trying to achieve this goal. Meanwhile, there seems little prospect that Asian central banks will decide on a wholesale shift in their currency intervention policies. So long as they remain committed to currency stability against the dollar, they will continue to sell their own currencies into the foreign exchange markets, buying dollars and, importantly, dollar assets.
In normal circumstances, the US might complain about this Asian currency intervention but, this time, things are a little different. Asian central banks are buying lots of US government paper which means that the US government is, in effect, receiving a subsidy from Asia. This, in turn, helps explain why US 10-year Treasury yields are below 4 per cent, despite the strength of the US economic recovery and weakness of the dollar.
Great news for the US, great news for Asia but absolutely hopeless news for Europe, given the implied strength of the euro. It's no surprise that Europeans are beginning to complain that this looks increasingly like a Machiavellian conspiracy, with the US and Asia delivering a growth pact for themselves that, at the same time, looks like an "anti-growth" pact for the Europeans. This is not just a story about lost competitiveness: it's also a story about default. Every time the dollar declines, all those Europeans who bought dollar assets in the late 1990s in the belief that the US truly did offer a "new paradigm" suddenly find themselves worse off.
Europe loses, then, on two counts: deteriorating competitiveness and falling asset values in euro terms. Yet the ECB refuses to do anything about this, claiming that interest rates are low enough and that Europe's remaining growth difficulties result from a lack of structural "supply side" reform that only governments can deliver, not the central bank.
As always, there is some truth in this story but this week's charts suggest that it's not the whole truth. Whether the ECB likes it or not, the euro's strength has occurred during a period when European short-term interest rates have been persistently higher than those in the US. And if I am right in thinking that the euro's strength has played a role in restraining European growth, it follows that, indirectly, the ECB's policies may also have played a role.
The Europeans may be hoping for some respite, some help, from the US and Asia at the next G7 finance ministers' meeting in February. But why should the others help? They're doing very nicely indeed and could quite easily point out that Europe's problems would be a whole lot less if only the ECB were to cut rates.
The ECB won't like this message but what are its other options? Nothing the Europeans can do will persuade the Americans to raise interest rates. And the Europeans are powerless to influence Asian central bank policies. So Europe's tummy upset is set to continue, unless the ECB itself encourages this group of sickly economies to get out of bed, make a run for it, and get to the toilet in time. Far better to face facts, cut interest rates, and get economies back on to a reasonable footing than to wait around hoping that the economic nausea will eventually go away.
Stephen King is managing director of economics at HSBCReuse content