Europe is in a dilemma, caught between its geopolitical obligation to impose meaningful economic sanctions against Russia and its domestic obligation to counter low inflation and slack economic activity. The first duty should put upward pressure on the euro, while the second requires the currency to fall in the foreign exchanges.
Meanwhile, Russian President Vladimir Putin is hoping that Europe’s current domestic economic difficulties will cause it to back off sanctions.
There’s a way out of Europe’s dilemma, but it requires the full cooperation of the U.S. A joint currency intervention to lower the euro would help Europe deal with low inflation and slow growth and, at the same time, increase the credibility of sanctions by neutralizing their impact on Europe.
The sight of Europe and the U.S. cooperating on a major policy initiative would certainly take the wind out of Putin’s sails. In pursuit of his expansionist agenda, he wants to split Europe and the U.S., not unite them.
But would the U.S. cooperate? So far, the U.S. Treasury has essentially said to Europe: First you do quantitative easing, and then we can talk.
The crisis in the Ukraine, however, has given Europe new leverage. The existing joint sanctions may have to be broadened or tightened; Europe will have to be on board with any changes.
Besides, to a good extent, the current high value of the euro has a lot to do with the extraordinarily loose monetary policies of the U.S. Federal Reserve.
If the U.S. wants Europe’s help in countering Russia’s expansionism, it should be willing to pay for it with a higher dollar. Germany just revoked permission for the technology company Rheinmetall AG to build a Russian military training center. That costs Germany. The U.S. wants France to follow suit by canceling its deal to sell Mistral warships to Russia. That would cost France. Shouldn’t the U.S. do its part by cooperating on joint intervention?
From a monetary policy perspective, the more the U.S. tightens now by bolstering its currency, the less the Federal Reserve will have to do later on by hiking interest rates.
Of course, it’s not only the U.S. that must sign on to joint intervention — Germany also must agree, and there are real questions whether German Finance Minister Wolfgang Schaeuble would want to. As far as the German economy is concerned, the euro is not overvalued.
My guess is that he would agree anyway — first, because Chancellor Angela Merkel would not want to see Europe backslide on the sanctions, and second, because Germany does not want to see Europe lapse into recession, which would probably spell the end for the Stability Pact.
What’s more, the German public is more likely to accept joint currency intervention than its alternative — quantitative easing, or bond buying.
Europe appears to be allergic to quantitative easing. Even among those at the European Central Bank who recognize that the policy would counter continuing low inflation have no great enthusiasm for it. They do not trust that it would push the euro down.
The stubbornly high euro impedes both Europe’s economic recovery and its ability to thwart Russia’s expansionist agenda. The U.S. has a clear-cut interest in ensuring that Europe does not fall back into recession or backtrack on the sanctions. Joint intervention to sink the euro is the right strategy for both sides.
Melvyn Krauss is an emeritus professor of economics at New York University and senior fellow at the Hoover Institution, Stanford University.