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Business

Falling Euro May Signal Deeper EU Woes

Euro zone members have watched their currency fall sharply against the dollar in recent days, as forex markets react to the complex global financial crisis. But observers disagree on the possible effects of the decline.

A counter where Euros are being sold for dollars

A dollar will buy more euros these days

Analysts took conflicting lessons from the euro's fall to two-and-a-half-year lows, with some saying the fall is a short-term problem that could help boost exports, while others saw it as a sign of serious policy discord in the 15-nation euro zone.

In European trading on Tuesday, Oct. 28, the euro touched a low of $1.23 -- the last time it was so weak was in April, 2006 -- before reaching $1.25 in Asian trading. The currency fell even farther against the yen; in all it weakened against 14 of the 16 most active currencies.

Analysts attributed the drop to a number of factors, including the widespread perception that Europe's economy is on the brink of a recession and the expectation that European Central Bank President Jean-Claude Trichet may soon lower interest rates.

'A question of politics'

Exchanges rates aren't just a question of economics, "it is a question of politics," said Ognian Hishow, a German economist who is currently a visiting professor at the University of Rochester.

A board where euro prices are noted in the Frankfurt boerse

The last time the euro fell so low was in April, 2006

"Once the world starts to get suspicious of a given player -- like the euro zone now -- then they will look for an alternative for where to put their money," he said. "Right now, the only good alternative is the US dollar."

Alexandra Boehne, a finance expert for the German Chamber of Commerce, noted that the falling euro reflects the growing concern over the extent of the European financial crisis.

"No one knows how the financial-market crisis will develop, how long it will continue and how bad the economy will get," she said.

Financial players have known about the economic crisis in the US since last year, but the news that Europe is heavily affected is new to the market.

'The markets are insecure'

"People have only been aware of a problem in Europe since the autumn of 2008," she said. "The markets are very insecure right now."

Some analysts say European banks' heavy exposure to credit-soaked emerging markets, particularly in Eastern Europe, has left the currency vulnerable. Bloomberg news service cited a report on Tuesday that showed European banks' lending to emerging markets is around 21 percent of Europe's gross domestic product, compared with 4 percent for the US and 5 percent for Japan.

Meanwhile there are other indicators that recession may be around the corner -- including a ground-shaking report on Monday that German consumer confidence had plunged to five-year lows.

falling dominos

The financial crisis: a game of dominos

In the end, "investors conclude that America is still the most reliable destination when it comes to where to put your money in such rainy days," Hishow said.

Not all analysts agree about the extent of the euro problem. The Chamber of Commerce's Boehme said it could actually give Germany's giant export economy a boost by making things "made in Germany," like automobiles and chemicals, cheaper.

Pessimism on export growth

According to Hishow, however, this would be the case if it weren't for the fact that Germany's main export markets -- the US and the rest of Europe -- are stagnating.

"Where can German companies sell their goods? In America? In Latin America?" Hishow asks rhetorically.

"In the dollar area it is impossible because of the downsizing there, and China, while its currency is pegged to the dollar, is facing hard times too, so there's not enough help there," he said. "I'm not optimistic."

Meanwhile Christian Dreger, an economist at the German Institute for Economics Research (DIW), argues that the drop in the euro is merely a temporary blip. Compared to the 80 US cents that the euro was trading for in 2002, the European currency is still strong, he notes.

Jean Claude Trichet looking pensive

ECB head Trichet: plans to cut rates?

He expects the euro's "short term drop" to reverse itself. He calls the bout of euro-selling an "adjustment" to issues of monetary policy, namely "pressure on the euro because of potential for further interest rate cuts."

Upside for the dollar?

Dreger says he disagrees with the investors who are betting that Europe will recover more slowly than the US. He thinks they are overreacting to possible weakness in Central European economies, and believes the euro will appreciate because "it will benefit more from catching-up processes in emerging markets like China and India, where the EU is heavily invested."

Economist Hishow disagrees. Over time, he says, there will be a correction in the American trade balance and the dollar will improve.

Moreover, he said he strongly believes the financial crisis and the falling euro are signals of deep underlying problems in the euro zone.

European integration at fault

"This crisis is a proof of how incomplete European integration is," he said. "When there are hard times, there is no unified response."

As examples he cites the vociferous controversy between Germany and France on how to respond to the economic crisis, and points out that if anything, the euro zone countries are drifting apart economically.

"They tend to act in self-interest first and foremost," he said.

He predicts the dollar's dominance as a reserve currency will continue unless Europe manages to find a way to boost the process of integration.

"I know many Europeans don't like this conclusion, but it is the reality," Hishow said. "So we have to accept it."

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