I normally wouldn’t call for the US Government to intervene in foreign exchange markets, but I think we are posed with a difficult and unusual problem. Also, I don’t mean simple swap lines, but rather an increase in US international reserves is required. My personal view, as I have expressed on a number of occasions is that the peripheral countries of Europe should leave the Eurozone quickly. As the Greek problem has become worse, and as the contagion from it has become more pervasive, the euro has fallen significantly against the dollar.

My concern is that this decline in the euro may accelerate. Even if it doesn’t fall further, the significant depreciation that has already taken place against the dollar puts the US recovery at risk. A major source of the V-shaped recovery we are witnessing in the US is the restocking of depleted inventories and the restart of investment by firms which were negatively affected by the financial meltdown.

The US economy has benefitted from a significant turnaround in its trade balance, in part due to the economic slowdown, and in part due to the decline of the dollar, which made imports more expensive and exports cheaper. If the euro stays where it is, or falls further, it may become far riskier for US firms to restock from US sources. The fall in the euro is a boon for Germany and France. Their fiscal positions are in decent enough shape that despite the higher euro that had occurred prior to the recent crisis, they were surviving the worldwide downturn rather well – all things considered. On the other hand, the US recovery is somewhat more fragile and does not need a declining euro putting downward pressure on US growth, even if only on the margin.

To insure against that happening, the Treasury should significantly increase its holding of euros and other advanced industrial country currencies which are suffering from the contagion posed by Greece and the failure of the eurozone as a single currency unit. The risk to the US government is that it might suffer some minor fiscal losses if the euro or these other currencies decline further. However, if the intervention works and provides time and stability to the eurozone, then the Greek problem, along with the other structural problems posed by the poorly structured eurozone may be fixed at a more leisurely pace and contagion reduced.

Given that the US is not in danger of runaway inflation anytime soon, and its ability to sterilize much of the inflow, it looks like a no-brainer to me. The Fed should immediately start purchasing euros and other appropriate currencies on behalf of the Treasury. For once the US government should put Americans and American jobs first. At the same time, the windfall gains France and Germany will attain will be reduced and redistributed to US-based industries and workers.

Tags: Dollar, euro, eurozone, Foreign Currency Intervention, France, Germany, greece