Serious Anxiety about the Dollar… In Europe

Last night there were a few hours of near-panic in the currency markets as the result of a report that the EU was considering the imposition of capital controls to slow down the euro’s appreciation against the dollar. Capital controls in this case would presumably limit the amount of European assets (e.g. stocks, bonds, bank accounts) that non-EU citizens could purchase in any given month. Such a move would reduce the demand for euros, and thus help to keep the euro from rising further against the dollar. Such a move would also be totally shocking to the financial world, since they take for granted the perfect freedom that they currently have to move money in and out of Europe whenever they want.

I think that this rumor says something very interesting about the level of anxiety both in Brussels and in the currency markets about the dollar’s fall and euro’s rise. As this CBS Marketwatch report notes, it’s high.

LONDON (CBS.MW) – It says a lot about the current state of the foreign exchange market that a report Brussels is studying 1970s-style capital controls to stem the euro’s rise received any attention at all on Thursday.

Europe can hardly lasso in the euro with exchange controls, and London currency analysts quickly dismissed the report in the Daily Telegraph. Yet the hullabaloo the report caused in overnight trading lingered. It may be signaling some unease with the relentless dollar selling.

The euro has struck a fresh all-time high against the dollar every day this week, outside of the slight decline Thursday. The common currency has been on a tear despite the stunning string of U.S. economic data for the third quarter…

[T]he fear among Europeans is that the euro is bearing the brunt of the great dollar correction underway because Asian nations – notably Japan – are intervening to force a more measured dollar decline against their own currencies. The pressure is bound to build on European policy makers to do something as the dollar continues to slide.

The EU has vigorously denied that they will impose capital controls, and I believe them. However, this episode makes me wonder if they are worried enough about the rise of the euro to be considering some intervention in currency markets to try to prop up the dollar and keep the euro from getting stronger. I’m reminded of the possibility of the three-way currency contest that I discussed back in October. If the ECB is indeed considering such intervention, things could get very interesting indeed…