Mr Buffett believes the dollar has further to fall and the US trade

Caroline Baum is a columnist for Bloomberg News. The opinions expressed are her own. Euro May Turn Out to Be the Dollar's Best Friend: Caroline Baum March 30 (Bloomberg) -- Just when everyone on the planet concluded that the U.S. dollar had nowhere to go but down, the dollar rallied. Whether the reversal of fortune proves to be short-lived or sustained, technical or fundamental, remains to be seen. The forces conspiring to make the dollar the currency everyone loves to hate -- the big, bad current-account deficit, which hit 6.3 percent of gross domestic product in the fourth quarter of 2004, and the record budget deficit, with no newfound religion on spending in sight -- are still with us. However, all that needs to happen is for folks to like another currency less. They don't have to learn to love the dollar more. Consider the currency market's euro preference over the past couple of years. It had little to do with the prospect of high returns in Europe and everything to do with its non-dollar status. ``It was the un-dollar,'' says Dan Katzive, a currency strategist at UBS AG in Stamford, Connecticut. ``It was the alternative to the dollar. No other currency has the liquidity and size to be a reserve currency.'' In other words, the strength of the euro was not unlike the support for Democratic presidential candidate John Kerry: No one much liked him, but at least he wasn't George W. Bush. Qualified Strength While currency analysts have tied the dollar's turnaround to the Federal Reserve's get-tough language on inflation last week, the euro's recent peak against the dollar came a full 11 days before the Fed met, raised the overnight federal funds rate by 25 basis points to 2.75 percent and opened the door to potentially bigger rate increases ahead. Is it possible the euro's decline over the past two weeks had something to do with European leaders' measures for ``strengthening and clarifying'' the Stability and Growth Pact? The SGP is the 1997 regulation that stipulated the budgetary caps -- a 3 percent deficit- to-GDP ratio and a 60 percent debt-to-GDP ratio -- for countries signing on to the European Monetary Union, caps that were also laid out in the Maastricht Treaty. What European Finance ministers see as strengthening and clarifying might appear to an outsider as formalizing hanky-panky with the rules. ``You can't appear to make it up as you go along if you don't have a country behind you,'' says Andy Smith, an analyst at Mitsui & Co. in London. ``The edifice is being stress-tested.'' Germany, which insisted on the fiscal restraints as part of the Maastricht Treaty, has exceeded the 3 percent deficit-to-GDP cap for the last three years and wanted more flexibility to grow (i.e., spend). France and Italy agreed. Bigger Is Better The big countries had their way. On March 21, European Union finance ministers agreed to ease the rules, providing exemptions for meeting the deficit ceiling (slow growth) and giving Germany a pass for the cost of reunification -- that's East and West Germany, Smith says, not Prussia -- in 1990. It's as if Germany gets to restate earnings for the last 15 years in a more favorable light. The ECOFIN report (ECOFIN stands for the Council of Economics and Finance Ministers of the EU) to the European Council (the main decision-making body of the EU, with each member state represented) is heavy on acronyms, which is generally a bad sign. Alphabet Soup For example, member states must adhere to the MTO (medium term objective) for budgetary positions of CTBOIS (close to balance or in surplus). MTOs may diverge from CTBOIS by a margin dictated by a member state's status as a low-debt/high-potential-growth country or high-debt/low-potential-growth country -- in cyclically adjusted terms, net of one-off and temporary measures, and taking into account ``room for budgetary manoeuvre'' to accommodate ``public investment.'' (I kid you not.) Only structural reforms that have long-term cost-saving effects will be considered as MTO-compliant initiatives (legitimate deficit- busting projects, in other words), pending a detailed cost-benefit analysis from the member state. Why, the paperwork alone could bust the budgets of even the low- debt/high-growth-potential countries! While the euro always faced challenges because of the nature of the union -- it's monetary, not political -- the needed adjustments in the single-currency zone and degeneration of the EMU are coming quicker than even the skeptics predicted. Beginning of End? ``We're seeing the beginning of that process,'' says Larry Kotlikoff, chairman of the economics department at Boston University, who has written about the growing fiscal burden that will strain the monetary union. The deficit-to-GDP ratio is a ``non-measure to begin with'' because it fails to capture the long-term fiscal imbalance of most of the euro zone's member countries, Kotlikoff says. (Specifically, the burden of caring for an aging population that will fall on future generations and is captured by something called ``generational accounting.'') ``The fact that they had to throw that criteria out the window just because countries didn't find it convenient is indicative of a larger problem,'' he says. ``The U.S. has major fiscal problems, but they are less significant than those faced by Europeans,'' Kotlikoff says. ``Europe is aging more rapidly, and benefit levels relative to living standards or per-capita income are higher.'' Ultimately that burden will require ``tax hikes on a scale unprecedented in peacetime or drastic government spending cuts,'' neither of which is palatable, Kotlikoff and Niall Ferguson wrote in a 2000 Foreign Affairs article, ``The Degeneration of EMU.'' The only other possibility is for the European Central Bank to inflate its way out of the problem, enabling the government to pay its obligations in a devalued currency. At that point, with the euro sinking, countries that weren't enamored of the euro to begin with will wonder what on earth they are doing as part of a monetary union. In the short run, a weaker currency will improve Europe's export growth, deferring structural reform to another day. If that's the goal, then tinkering with the EMU rules -- and undermining the euro -- may be the perfect solution. Original story ..