In a meeting earlier this week, European finance ministers substantially changed their public rhetoric and informally adopted what amounts to a “strong euro policy.??? Since the euro’s creation in the late 90’s EU policy makers have focused on the need to restrain its appreciation for the benefit of exports. Instead ministers are now cheering the benefits that a strong euro has on restraining inflation and keeping a lid on import prices, particularly commodities such as oil.

With the change in tone these European officials now resemble former U.S. Treasury Secretary Robert Rubin, whose constant rhetoric (characterized by the markets as a “strong dollar policy???) was widely credited in helping keep U.S. inflation and interest rates low during the Clinton administration.

With the belief in the “strong dollar,??? and the currency appreciation it implied, global capital in the 1990’s (and the early years of the Bush Administration) flowed into dollar assets. This result ultimately provided American consumers with lower prices and falling interest rates, and U.S financial markets with higher stock and bond prices. If the “strong euro policy??? has similar results, European consumers and capital markets will accrue similar benefits. If this policy is also adopted in Asia, when it is concluded that cheaper imports and heightened domestic purchasing power outweigh the benefits of competitive exports in the American marketplace, then it’s all over for the over–valued dollar.

The immediate result of the currency realignment for Americans will be upward pressure on the price of U.S. imports, as they are forced to bid for the world’s scare resources with currency of diminishing value. However, the most serious results will be a rise in U.S. interest rates, which will be needed to attract financing for the twin government and current account deficits. Higher rates will finally help prick the housing bubble, the shaky foundation upon which the U.S. “house of cards??? economy now rests. The resulting recession will hasten capital flows out of the dollar, further accelerating the process. In other words, it’s “game over.???