Wednesday, December 30, 2009

>The dollar/euro exchange rate: Potentially, very significant instability

Since the start of 2009, the dollar has depreciated against the euro as a trend. This depreciation is no longer due to the same causes as before the crisis: the US external deficit has shrunk drastically, but the changeover to virtually zero dollar interest rates has led to massive capital outflows from the United States, and this is currently the cause of the dollar’s weakness.

However, the dollar/euro exchange rate may prove to be very unstable:

for the dollar to depreciate against the euro, the sum of the US external deficit and the capital outflows from the United States must outweigh the purchases of dollars by central banks in emerging and oil-exporting countries, which want to stabilise their exchange rates against the dollar;

a faster rise in interest rates in the United States than in the euro zone, a rise in risk aversion after an unfavourable shock or a fall in the oil price due to sluggish growth would lead to a reduction in the borrowing positions in dollars or long positions in euros that would stop the depreciation of the dollar against the euro.

We might therefore see (in 2011?) a drastic changeover to an equilibrium where the dollar appreciates markedly against the euro once again, something that would obviously be a serious problem for the US administration.

To read the full report: DOLLAR/EURO