Until recently, the euro has been moving consistently higher against the other major currencies, at one point hitting highs of $1.20 and 140 yen. But its rise appears to have slowed now, with the new unified currency now stuck in the $1.17-$1.18 range.

One of the reasons behind this weakening was the June 5 decision by the European Central Bank to cut its key interest rate by 0.5 percentage points to 2 percent. In theory, a currency’s exchange rates will fall after its interest rate has been cut, because that makes it less attractive to own. But right after the ECB’s announcement, market players instead started selling the dollar — whose interest rate had now gained relative to the euro — pushing up the value of both the euro and the yen.

This happened because of widespread speculation that United States monetary authorities would follow the ECB in reducing interest rates. Unlike in Japan, there is still more room overall for cutting U.S. and European interest rates, and a rise in the yen would only be natural in such a situation.

Another reason is U.S. President George W. Bush’s announcement during the Evian summit of Group of Eight leaders that the U.S. would continue to pursue a strong dollar. However, Washington’s true intentions appear to be bit different, given the further rise anticipated in its external deficits due to the decline in tax revenues and the cost of its operations in Iraq. I believe the U.S. government will condone a modest decline in the dollar, as long as it does not negatively affect the inflow of funds that are making up for its current account deficit.

The dollar’s downtrend will continue after this lull, because new factors have materialized from the international divisions created by the Iraq war: the gap between the U.S. and the continental European powers of France and Germany, and the divide between the U.S. and the Islamic world.

One of the major elements behind the dollar’s slide is the destabilization of the external debts of the U.S., or moves toward asset diversification that are apparently linked to growing antipathy toward U.S. unilateralism. This reversal in the flow of funds — from the U.S. to Europe — originated as a move to make up for the losses incurred by European firms. It is now expected to accelerate gradually.

This fund outflow is likely to have a sustained impact. The U.S. suffers from a current account deficit equivalent to more than 4 percent of its gross domestic product, and its accumulated debt is expected to reach $2.5 trillion on a net basis. Its total debt is already believed to top $9 trillion. We need to closely watch moves by developing countries, as well as Asian economies with large amounts of foreign currency reserves, to see if a further shift occurs from the dollar to the euro.

In addition, anticipating “21st century-type” risks, such as the 9/11 terrorist attacks, the SARS outbreak or the turmoil in the Middle East that President Bush is attempting to mediate, remains a hefty job. The old axiom “Don’t put all your eggs in one basket” remains completely relevant in this day and age.

A second major element is moves by some oil exporters to trade crude oil in euro terms. This is another form of diversification — a way to avoid accumulating dollar-denominated assets. The fall of the dollar played a major role in the two oil crises of the 1970s, because the weaker dollar eroded the income of oil exporters in real terms.

This shift to euro-based trade is also linked to the division over the Iraq war and has been observed in Indonesia, the largest Islamic nation and oil producer in Asia.

Of course, the euro has its own problems: the economic slump in its region that triggered the ECB’s rate cuts. Germany, in particular, suffered negative growth in the October-December quarter, and its unemployment rate has hit 10.7 percent — much higher than the euro zone’s average of 8.7 percent. In addition, Germany’s budget deficit is likely to exceed the regional standard of 3 percent.

We should keep an eye on how the European Union or Germany deal with this situation, since the euro’s strength is being supported by the fiscal discipline its member nations have agreed to have imposed on them. Increased participation in the EU by East European nations is also likely to have an impact on the euro’s value.

The new trends resulting from the international division over the Iraq war are having a wide-ranging impact on the global economy that is being felt beyond the domain of the currency market.

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