The recent evolution of the parity between the two major international currencies, the dollar and the euro, is full of lessons and will not be without consequences on the French economy. The euro remained stable against the dollar during almost two years, if we exclude a short period of doubt in November 2015. It fluctuated between 1.10 and 1.15. American elections approaching and the narrowing of the gap between the democrat candidate and Donald Trump generated a rise of the dollar. It reached 1.05$ against the euro, its highest level for 20 years, shortly after the election of the republican candidate. Then it moved between this peak and 1.10$ during almost 6 months. Since that, the path of the American currency reversed and the euro is progressively approaching its 1.15$ level it had two years ago. Two reasons explain the change of its trend.
The Donald Trump economic program included massive tax cuts and investments in infrastructures for 1000 billion dollars. Financial markets then thought that this program would generate an acceleration of the growth of the American economy. So, the central bank, the Fed, would be inclined to adopt a more restrictive monetary policy through several interest rates rises and international investors would be incited to choose dollar denominated assets, which would contribute to the rise of the currency. But the scenario did not go off as they hoped. The American president was not successful in dictating his proposals to the Congress and many of his decisions have been censored by judicial authorities. So, it is his ability to put in practice his economic policy which has been questioned, notably regarding fiscal issues about which the Senate and the House of Representatives have many times issued critical opinions about his rebound program. It is long to be put in practice for all these reasons. American growth figures for the 1st quarter of the year, even if the first estimation has been revised upward, have also been disappointing. According to that, the probability of a tightening of the monetary policy is fading and investor anticipations went back. The Fed will probably increase its rates in the coming days but the number of rate increases for this year should be revised down. For that reason, the dollar has started its decline against the euro, and, which has surprised many commentators, also again the Chinese currency, which had been many times betrayed as weak, by some of them, or manipulated by the others. It rose to 6.79 Yuan for one dollar, from 6.90 a couple of weeks ago.
We can take two lessons from these moves. The first one is about Donald Trump credibility regarding economic policy. It was already criticized about his foreign policy. It is now his economic action which will be put into question. The debate about the increase of the public debt ceiling, which will occur during next summer promises to be bumpy. The second lesson is more important: currency fluctuations are not, as in the past and as it is still teach, provoked by physical exchanges of goods and services but by financial flux which are guided by investor anticipations about central banks decisions. It is not any more the surplus or the deficits of trade balances which have influence on exchange markets but the evolution of interest rates, being themselves dependant of growth and inflation forecasts of the considered zone. The euro is rebounding because economic conjuncture is improving in the area and because, as it is thought, the European central bank will have sooner or later, to moderate its policy, even if inflation is still far from having reached the 2% target. In offering less penalizing interest rates, foreign capital will be attracted. The economic thinking must adapt itself to these realities which are much less new than it is generally thought.
The first serious impact of monetary events on economic equilibriums occurred in 1979 when Paul Volker, chairman of the Fed, adopted an ultra-restrictive policy shooting interest rates above 15%. As a result, dollar had a staggering increase. It rose, until the Plaza agreement in 1985 stabilizes the situation, from 4.50 FF until 11.20 FF. Such fluctuations would be unthinkable today. In France, the increase of the trade deficit between 1980 and 1982 was attributed to the consequences of the growth gap between our country, which did profit from the 1981 rebound policy, and its partners. But it was wrong: the augmentation of the trade deficit was the consequence of the increase of the oil bill, which was paid in dollar, itself generated by the rise of the dollar. A second crisis occurred in November 1987 when financial markets misinterpreted the simultaneous declarations of the Fed and the Bundesbank. During the day, Wall Street lost more than 20% and the European markets followed the trend the next day. A new and very violent crisis occurred during the 1992 summer, when the pound had to exit from the European monetary system. France had to massively increase its interest rates which put the country in recession and contributed to the defeat of the left in the following elections in March 1993. The Asian crisis in 1994, the explosion of the Internet bubble in 2001 and, at last, the great financial crisis of 2007-2008 generated heavy difficulties in their areas and even, in the world economy for the last one. Now, crisis are coming more from financial disequilibrium than from economic ones.
It is necessary to take that into account. The progressive reduction of the gap between the policies of the Fed and the ECB will provoke a rebound of the euro. We already see the first signs. It is a factor of instability. But that evolution can happen without provoking shocks if both institutions have a well coordinated communication policy. The consequences for the French economy, if the transition is a smooth one, are much less negative than those who favor a weak euro, are saying. They welcomed the rise of the dollar because they thought it was good for our trade balance. Facts showed they were wrong: that did not help to stimulate significantly our exports but that increased as in 1982 the cost of our imports because a lot of them like fossil fuels cannot be reduced. France has only partially taken advantage of the oil price fall because the rise of the dollar did reduce its impact. Without energy items, our trade deficit even increased, and that, despite the many advantages given to companies to help them to restore their competitiveness.
The economic policy will have to adapt itself to this new context which, in reducing their supplying costs, will benefit to enterprises. It won’t be appropriate to increase again the transfers they receive through the supply side oriented policy. On the opposite, what they need is to find in their own market a significant growth support.