Source: Carnegie

By Moises Naim

Originally published in the Financial Times, on May 19, 2003

For more than a year, the deteriorating political relationship between the US and Europe has provided rich fodder for analyses, dire predictions, threats and appeals. Meanwhile, as politicians, diplomats and generals fret over the geopolitical causes and consequences of the worsening health of the transatlantic relationship, the US dollar has been sliding against the euro.

The dollar recently hit a four-year low in its value against the euro; most experts believe that it will not regain its strength for some time. And that points to a truth that is yet to be fully recognised on both sides of the Atlantic: a US dollar whose value relative to the euro has plummeted by about 40 per cent since late 2000 and whose depreciation has sharply accelerated in recent weeks will have more serious consequences for the transatlantic relationship than all the earnest diplomatic manoeuvres, speeches and articles on the subject.

The first and most obvious consequence is that Europe will be flooded by American exports, while the US will see a surge of European tourists whose apprehensions about George W. Bush's unilateralism will be tempered by inexpensive opportunities to take the children to Disney World. Americans will not switch to Californian wine because of France's vote in the UN Security Council but because French wine will become more expensive.

The fall of the dollar will make life more difficult for European industries while making American companies more competitive. The US private sector has already been sharpened by its ruthless and profound restructuring in response to the bursting of the stock market bubble, a slow economy, corporate scandals and the shock of terrorism and war. In contrast, Europe's labour market rigidities, heavy business regulation and closed corporate ownership structures have reduced the ability of many of its companies to react swiftly to changes in the global economy.

A cheaper US dollar will be a big challenge for European corporate leaders, for public policymakers and for union leaders. Managers in the eurozone will face unprecedented pressures to cut costs, policymakers to save and create jobs and union leaders to protect the generous benefits that they have secured for their members over the years. A strong euro could spur the creation of the coalitions needed to undertake long-awaited and so far postponed structural reforms.

But the reform agenda is so daunting, and implies such wrenching social and political rearrangements, that European governments may be tempted to retreat instead behind subsidies and protectionist barriers. In the absence of reforms, some companies may be able to shift their manufacturing to cheaper and friendlier locations but most will have no option than to press their governments for more subsidies and greater protection. As job- lessness increases, political demands will intensify to save the domestic jobs lost to imports and industrial relocation and to stem the flow of immigrants.

A weaker US dollar may also dim prospects for trade liberalisation. The World Trade Organisation's Doha round was already facing an uphill battle; negotiating trade opening in the midst of growing unemployment and an import surge may make the hill impossible to climb. Sadly, the newly realigned currency may also undermine the significant progress that European agriculture ministers had recently achieved in their talks to overhaul the EU's agricultural subsidies. If Europe deals with the strong euro by relying on protectionist measures, it will lead to more frequent and more acrimonious trade disputes.

All this suggests a paradox: that a weak currency is not always a sign of weakness. The US seems well equipped to minimise the negative consequences of a sharp devaluation of its currency while taking immense advantage of the opportunities it creates. A big factor in this is the flexibility and adaptability of the US economy, particularly of a private sector that is less fettered by regulations than its European counterpart and that must try to satisfy demanding shareholders.

Finally, the realignment of the exchange rates will change our thinking about international affairs. During the 1990s, finance became such a dominant factor in world politics that some experts argued that traditional security issues were becoming less relevant. September 11 2001 showed the absurdity of this idea and generals, military experts and muscular international politics returned to vogue. Soon the focus of attention will shift again. The declining dollar will help rebalance not only the US trade deficit but also the way we think about the world.

The writer is editor of Foreign Policy magazine