This morning’s coordinated forex market intervention on behalf of the euro was obviously intended to surprise the markets, coming in advance – rather than at the conclusion -- of this weekend’s meeting of G7 finance ministers and central bankers in Prague. In that limited sense it succeeded, precipitating a flurry of short covering that briefly pushed the currency above $.90. By late-morning, though, the euro had already retraced much of its $.04 pop, trading below $.88.  Following standard practice in these exercises, the liquidity effects of the intervention will be sterilized almost immediately by the respective central banks. The supply-demand relationships of the respective currencies – euro, yen and dollar -- will thus be left essentially unchanged, aside from a short-lived impact on speculators who for a time will be somewhat more cautious in setting short euro positions. 

More fundamentally, a short- to mid-run bull case for Europe’s beleaguered common currency is difficult to discern at this point. Although recent European Central Bank missteps have certainly been a contributing factor, the bulk of the euro’s decline from dollar parity early this year continues to be accounted for by appreciation of the greenback in real, commodity- related terms. That suggests that opportunity for a sustainable euro snap-back is keyed to prospects for a less stringent dollar through at least partial reversal of the Fed’s 175-basis-point- tightening since mid-1999. Those prospects, however, have been significantly complicated by the inflation risks generated by the recent oil-price surge (“Greenspan’s Dilemma,” Sept. 19, 2000).

The impact of rising oil prices, moreover, is being further magnified in the euro-zone by the currency’s weakness. While dollar-priced crude oil has run up by some 38% this year, that converts to a 63% spike in terms of the euro’s declining purchasing power. The additional hit is biting deeper into Europe’s growth expectations relative to those in the U.S. and thus further sapping euro demand. Given this vicious cycle, the possibility of a sustained oil-price retreat probably offers the best hope of near-term gains for the currency.

Taking a somewhat longer-term view, though, the picture has the potential to brighten considerably. Europe increasingly is marching under a supply-side, tax-cutting banner which presents real opportunity for releasing the entrepreneurial energies of a continent that has long been smothered in the embrace of failed statist governing ideals. Much yet remains to be done to deregulate rigid labor codes and anti-growth welfare-state guarantees. But the directional shift toward increasing the marginal after-tax return on productive economic activity is all to the good. The first steps in this spreading wave of change take effect next year, which should also coincide with a perceptible rise in euro investment demand.