Douwe Osinga's Blog: Countries and currency risks

Saturday, February 21, 2004

Countries and currency risks

The European leaders complain about the weak dollar and how a further weakening dollar could hurt the still vulnerable economic recovery. Companies that fear currency movements, routinely insure themselves against those risks by using options or currency swaps. What's stopping countries?

A dollar dropping below 1.30 to the Euro could do some serious harm to exporters in the Netherlands, hurting government income in turn. So you'd expect the governemnt to take steps to insure themselves against something like that. But they are actually making things worse.

Almost all Euro-countries borrow money and they borrow it in Euros. That means that in terms of dollars, when the dollar drops further, their debt increases. If they would borrow in dollars, their debt would decrease if the dollar dropped further, offsetting the damage of the lower dollar. If the dollar would recover, the debt would increase, but so would the economic recovery.

I'm not saying all Euro debt should be in dollars; this would carry the risk that when things go really bad and there is a run on the Euro, defaulting would become unavoidable, while if a country has debt denominated in its own currency, it can always print money. But I do think that there should be some debt in dollars, evening out the risks.