Stalling U.S. economy means euro is on the up*

With the U.S. economy stalling, the greenback's slide — and the euro's
rise — may be far from finished

By PETER GUMBEL | PARIS

Lynn Loring, a flight attendant for American Airlines, has been coming
to Paris for 18 years, and at times when the dollar was strong, she
says, "All I did was shop." But last week, walking around the Galeries
Lafayette department store, she was doing more looking than buying. The
reason: the dollar has been sliding against the euro, and that's making
everything much more expensive for her. "I'm so depressed," she says.

American Christmas shoppers in Paris aren't the only ones suffering from
sticker shock. The dollar fell to a near-record low of $1.33 to the euro
at the end of last week. It has shed about six cents since early
November, shattering months of calm on currency markets, causing a
mini-swoon on some stock exchanges and prompting French Finance Minister
Thierry Breton to call for "great collective vigilance." The dollar has
also slid against the British pound, which closed last week just a few
cents short of $2, its highest in 14 years. Many investors are betting
that the decline will continue. "The dollar has no friends in currency
markets at the moment," says Neil Mackinnon, chief currency strategist
for the British financial firm ECU Group.

Behind the abrupt movement is an important change of gear in the world
economy. After four years of buoyant expansion, fueled in part by
soaring house prices, the U.S. is now slowing. At the same time,
Europe's economy is enjoying its strongest growth this decade, powered
by a resurgent Germany. Growth rates on both sides of the Atlantic are
expected to be somewhere between about 2-2.5% next year, according to
various forecasts.

By comparison with recent years, those figures are measly for the U.S. —
but unusually robust for the Europeans. Central banks on both sides of
the Atlantic are reacting differently to the prospect. In Frankfurt, the
European Central Bank is continuing to raise interest rates — the next
hike is widely expected later this month. In Washington, meanwhile, the
new Federal Reserve chairman, Ben Bernanke, has ended the series of rate
increases introduced by his predecessor, Alan Greenspan, and Wall Street
has been anticipating the start of a period of cuts as the U.S. economy
loses momentum. This transatlantic divergence is pushing the dollar
down. (Note, however, that Bernanke sounded a hawkish note in a speech
last week, saying that inflation remained "uncomfortably high" — an
indication that he won't be reducing rates soon.) The big question is
whether the dollar will continue its decline over the next several
months, or whether the recent fall is a temporary blip. A sustained,
larger drop would make U.S. exports more competitive and help reduce
America's yawning trade deficit — but it would also stir up inflation,
as well as crimp the profits of European firms and hurt economic growth
there. It also risks bringing heightened volatility to world financial
markets. U.S. Treasury Secretary Henry Paulson, for one, thinks that's a
bad idea. "A strong dollar is clearly in our nation's best interest," he
said last week.

Despite some jitters, few are panicking yet. Jean-Michel Six, head of
economic research at Standard & Poor's in London, reckons the dollar
will fall to between $1.42 and $1.45 against the euro by mid-2007, but
even at that level, "we do not expect any significant impact on overall
growth" in Europe. German machinery companies are currently operating at
over 90% of their potential capacity, the highest since 1990, and are
thus well able to weather a weaker dollar, says Olaf Wortmann, an
economist at the German Engineering Federation.

Some contend that the greenback may already have been oversold. Currency
strategist Mackinnon says he urges caution when the market sentiment is
all one way. And in New York City, Ken Goldstein, an economist at
business research organization the Conference Board, reckons: "All we're
seeing is another one of those short-term moves that will peter out in
weeks or months."

The next clue about the dollar may come from Japan, where traders are
now speculating on whether the Bank of Japan will raise rates later this
month. The Japanese economy has been recovering from stagnation, and the
bank in July ended its policy of keeping interest rates at zero. But
rates remain very low — just 0.25% — and a hike could put further
pressure on the dollar.

The present level is bad enough for Kathryn Wimmer, an apparel designer
from Portland, Oregon, who was visiting a friend in Paris last week.
"When I came here six years ago, things were a little expensive," she
says. "Now you just watch the dollar going down every day. Pretty soon
it's going to be hard just to come here." As for Christmas shopping in
Europe, forget it. This year, Wimmer's only buying postcards.

With reporting by Jeffrey T. Iverson/Paris

 From the Dec. 11, 2006 issue of TIME Europe magazine