Do As I Say

Germany and France seem to finally have scuttled the eurozone’s Stability and Growth Pact:

BRUSSELS (Reuters) – The European Central Bank on Tuesday slammed an accord among finance ministers that relaxes the fiscal rules underpinning the euro by giving governments a range of let-outs to escape punishment over bloated deficits.

The euro zone’s central bank issued a statement just hours after ministers struck a deal in Brussels to rework the rules of the EU Stability and Growth Pact after repeated breaches of the pact’s deficit limits by Germany, France and others.

“The Governing Council of the ECB is seriously concerned about the proposed changes to the Stability and Growth Pact,” said the ECB, which is independent and sets interest rates for the entire 12-nation euro area.

Want to know the irony of all this? Franco-German deficit spending will likely make the euro stronger vis-a-vis the dollar.

Let me explain. The ECB is much more hamstrung than our Federal Reserve when it comes to interest rates and inflation. Berlin and Paris spending too much? The ECB will jack up rates. Higher rates mean higher yields on the bonds used to finance those deficits. In the US, the Fed is usually more concerned with growth than with inflation — and it can afford to be, given that American workers outperform European workers. (Productivity helps keep a lid on inflation.) With less inflation risk, the Fed can keep – and has kept – American interest rates low. Lower rates mean lower yields.

And so the euro gains against the dollar. After all, it pays better.

Meanwhile, the US economy continues to create much more wealth and many more jobs than the Eurozone has managed since the “economic miracle” ended 30 years ago. Since then, the dollar has been in a long term decline.

Ironic, isn’t it? The worse Europe’s economy performs, the more it costs us to buy their stuff.

NOTE: Yes, I know there are lots of other factors involved here. I’m just looking at one of them.