Sarkozy and the Euro’s Perfect Storm

The more French president Nicolas Sarkozy attacks the European Central Bank and the strong euro, the more he is criticized in the European media, by European finance ministers, European Union officials and the ECB itself. The critics are right. The fundamental reason behind France’s current economic weakness is its lack of competitiveness even in other euro-zone economies where the euro is not a factor.

But Sarkozy has a point. A perfect storm is forming in the foreign exchange markets that threatens to catapult the euro to levels that will make even the euro-zone’s most efficient exporter—Germany—unable to compete in world markets. If German exporters can’t compete at 1.50 euros to the dollar, what chances do French exporters have?

The euro is gaining ground for several reasons. A precipitating factor is that the Federal Reserve has had a dramatic change of heart about the strength of the US economy. Fed chairman Ben Bernanke is now extremely concerned that the economy’s housing market and mortgage problems will cause a recession unless interest rates are aggressively cut even if this means taking some risks with inflation.

This new “no recession” Fed policy has started the US dollar down the path to new lows. The decline will likely be sustained by the substantial US current account deficit, which found in Bernanke’s cuts the spark it needed to make its impact fully felt in foreign exchange markets.