Today, as the Euro hits a record high against the dollar, the political complaints were barely audible—in fact, compared to earlier anger over the “low” value of the Euro, politicians have been unusually calm in response to the Euro’s record value against the dollar. It’s all too easy, however, to gloss over a significant amount of concern held by European politicians, particularly French and Southern European politicians who are worried over the strength of their export position.

As the Euro flirted with record highs last week, a number of European politicians began to grumble. Italian Prime Minister Romano Prodi, while noting that Europe has so far handled exchange rate volatility well, said he hopes the Euro does not appreciate “too much.” European Central Bank Chief Jean-Claude Trichet reminded currency traders that “exchange markets should be aware there are two-way risks in any bet.” Laurence Parisot, Chairwoman of the MEDEF, France’s powerful business association, lamented that “It’s evident that we do not have a true exchange rate policy at the European level” to keep exchange rate fluctuations within what she considers to be a reasonable band. Within the last six years, the Euro’s exchange rate with the U.S. dollar has fluctuated substantially within a band of $0.82 to $1.36, roughly 60 percent.

The ECB has been criticized for the high value of the Euro (caused in part by rising European interest rates) in recent months. In December 2006, when the ECB raised its interest rate, indirectly causing the Euro to appreciate, Socialist French Presidential candidate Ségolène Royal criticized ECB Chief Trichet by saying that democratically elected leaders, not central bankers, should control instruments of economic policy: “It’s not up to Mr. Trichet … to decide the future of our economies, it is up to democratically elected leaders,” she said.  

If the Euro eclipses the U.S. dollar as a reserve currency, the value of the Euro could appreciate still further, making European exports even more expensive than they are now.

Royal was more bothered by the effect rising interest rates have on growth than on the high value of the Euro, but the other French Presidential candidate, center-right Nicolas Sarkozy, has been more direct. He explicitly tied the difficulties of troubled European aircraft maker Airbus to the high valuation of the Euro, saying that “A weaker euro should be a tool to help European industry … Ten cents of appreciation on the euro is a 1 billion euro deficit for Airbus. We didn’t create the euro in order not to make a single plane in Europe.’” 

Sarkozy wants to go further than talk, however. While speaking in the Northern French city of Lille, he argued in favor of a “diplomatic offensive,” led by France, to “lower the exchange rate of the Euro.” Sarkozy alludes to Article 104 of the Maastricht Treaty, which “gives control over the exchange rate to the EU finance ministers, acting by Qualified Majority Vote.”

How times change! Not long after the Euro was introduced as an official accounting currency in January 1999, European Central Bank Chief Wim Duisenberg came under fire for the allegedly too low exchange rate. In June 1999, when the Euro was worth about $1.04 (still far more than what would be its eventual record low), criticism began to mount. German Central Bank President Hans Tietmeyer, a highly respected Central Banker known as “Der Herr of the D-Mark” for his stewardship of a strong D-Mark before the Euro was created, said he “would not be happy” if the Euro fell further. In December 1999, as the Euro declined still further, German newspaper Die Welt expressed widespread German irritation at having given up the strong D-Mark, calling the Euro “butter soft.”

When the Euro hit its record low, in October 2000, the common European currency was worth just $0.82. Amidst the gloomy forecasts at the time, speculator George Soros predicted the Euro would fall to below $0.70! So worrisome was the slide of the Euro—falling repeatedly in spite of a rapidly rising European interest rate—that “nearly two-thirds of Germans wish they'd stuck with the mark.”

Part of what drove the currency to its all-time low in October 2000 were comments by ECB Chief Duisenberg that the ECB would not intervene if a war in the Middle East were to trigger a sharp change in currencies. Duisenberg also said, with abnormal candor for a central banker, that there would be “no further central bank intervention to support the Euro this side of the U.S. Presidential election on Nov. 7.” In brusquely removing these particular elements of uncertainty from the currency equation, Duisenberg prompted speculators to dump the Euro.

Yet the factors keeping the Euro in the doldrums during those years were far more fundamental, and they were largely outside the scope of Duisenberg’s control. As the BBC noted, these factors included “worries about the strength of European growth together with a view that the U.S. offers better returns and higher interest rates.” And importantly, as Merrill Lynch Economist Matthew Higgins explained at the time, "Of late it's been growth and earnings expectations which have been the main drivers of capital flows, and that's why so much Euroland capital has come to the U.S. Growth — and corporate earnings expectations — have been stronger here." These capital flows helped keep a persistently downward pressure on the exchange rate of the Euro to the U.S. dollar.

The worries of economists increased significantly during this period. In September 2000, French Central Bank Chief Christian Noyer said the Euro was “dangerously undervalued.” In the same month, Michael Mussa, Chief Economist of the International Monetary Fund, echoed the French Central Banker’s concerns, warning “that the euro was so "significantly misaligned" that it posed a risk not only to Europe's recovery but to growth in the United States and Japan as well.” The head of the Institute for International Economics in Washington, C. Fred Bergsten, said the low value of the Euro was “completely out of synch with the underlying economics,” adding that “If the big currencies get way out of whack, it can cause serious problems.”

Recognizing the sensitivity of the topic, Duisenberg said as early as November 1999 that “I am somewhat concerned that all the talk and all the hype about the external value of the euro might, to some extent, undermine in the people's mind the confidence they have in their new currency.”

No French political leader would tolerate Airbus going bankrupt, certainly not if a bankruptcy were caused by a European exchange rate considered to be abnormally high.

Fortunately for Duisenberg, there were also cooler heads in the discussion of the Euro’s ostensibly low value, but these formed a minority. In September 2000, as the Euro neared all-time lows, David Fairlamb, the European economics correspondent for Businessweek, wrote an opinion piece titled “A weak Euro isn’t a failed Euro.” And, recognizing the political dimensions of a cheap Euro, Steve Kettman wrote an article in Salon in October of 2000 with the subtitle “Why the nonstop decline in the value of its currency doesn't spell doom for the European Community.” Moreover, in 2005, long after Duisenberg had left the ECB (and died), Michael Deppler, director of the IMF's European department, emphasized that the relatively weak exchange rate of the Euro at the time was “good news for Europe as it helps its exporters.”

So, what now? Today’s record high against the dollar comes as the Euro is, in certain quarters, becoming a reserve currency replacement for U.S. dollars. This is a mixed blessing for Europeans: certainly it is prestigious to have the Euro potentially equal the dollar as an international currency of choice, and in fact, it is what many European politicians said they wanted when the Euro was first introduced.

But is it desirable? If the Euro eclipses the U.S. dollar as a reserve currency, the value of the Euro could appreciate still further, making European exports even more expensive than they are now (in addition to causing severe troubles for the United States). In French political terms, this would be a highly undesirable development given that “an exchange rate of $1.40 would endanger” the survival of Airbus. As Airbus struggles “to meet $220bn of dollar contracts from an operation with euro labour costs,” the heat is on. No French political leader would tolerate Airbus going bankrupt, certainly not if a bankruptcy were caused by a European exchange rate considered to be abnormally high.

But a Euro worth more than $1.40 (or even $1.50) would not just be problematic for Airbus or French exporters. True, Germany and countries that are economically closely linked to it (such as the Netherlands) have the ability to withstand the pressure of an expensive Euro, but France, Spain, and Italy do not.

A Euro worth more than $1.40 would cause significant difficulties for Mediterranean countries in general—potentially re-launching the political debate over the mandate of the European Central Bank, something that both Sarkozy and Royal have hinted at.

Unlike the American Fed, which has as a goal to keep growth high, unemployment low, and inflation low, the task of the European Central Bank is simply to keep inflation low, even if this adversely affects economic growth. If European growth were to falter and the Euro were to rise even further in value, many politicians from Southern Europe and France will put heavy pressure on the ECB to lower interest rates. This would lower the value of the Euro but also lead to higher inflation, the mortal enemy of the ECB. It would have all the makings of a fascinating financial feud.

The discomfort brought about by the Euro’s “low” value to the dollar was mostly a matter of prestige. Now that the Euro is worth far more than the dollar and still rising in prestige (and value), its value is becoming a matter of tangible economic and political concern. Stay tuned.

Jurgen Reinhoudt is a Research Assistant at the American Enterprise Institute.

Image credit: Photo by Flickr user danrandom