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September 15, 2000

European Central Bank To Intervene In Currency Markets: ECB's Test
By The Financial Times

ECB Intervention Threatens U.S. Dollar ... Weiss comments

FRANKFURT - For a move that was meant to be merely routine, yesterday's announcement by the European Central Bank that it was using interest income on its foreign exchange reserves to buy euros caused quite a stir.

With the euro at new all-time lows against the dollar, no one was fooled by the claim that this was just a technical adjustment. Even Wim Duisenberg, the ECB president, admitted that the timing of the action was partly "tactical," and did not attempt to hide his pleasure at the reaction in the currency markets.

The ECB's move was rather clever. The euro had been sinking because the currency was seen as a one-way bet. The repeated statements by finance ministers and ECB officials that intervention was always available sounded less and less credible as the euro continued to fall.

By buying up a small quantity of euros, and dressing it up as a technical move, the ECB has been able to test the market's reaction without risking the loss of credibility that a failed intervention would cause. The signs were fairly encouraging. The announcement of the purchase of 2.5 billion euros over several days - compared with total daily turnover in the euro of around 130 billion euros - moved the exchange rate, temporarily, by over a cent against the dollar.

After this precedent, traders will be expecting further intervention. If this is not forthcoming, the euro could sink further. The ECB will therefore be looking carefully at today's events to gauge whether such action might work.

The euro is almost universally acknowledged to be undervalued, and the market may be ready to turn if given a push through intervention. Crucially, the ECB has plenty of reserves, and can threaten to impose a lot of pain on the euro bears.

Centrally, the ECB holds a relatively modest 42 billion euros in reserves. But in a hangover from pre-single currency days, national central banks also still hold their own reserves. This makes the total reserves of the euro-zone some 260 billion euros, or 381 billion euros if gold is included.

This is way out of line with the US, which holds only 67 billion dollars in official assets. The euro-zone's reserves are higher than can be economically justified, and it could easily afford to use some for intervention.

The ECB, though, may be hesitant to intervene without the help of its counterparts in the US and Japan. Multilateral agreements have often proved more effective than unilateral moves.

The ECB has put an element of risk back into the euro currency markets. It must now make the much harder choice of whether to attempt to turn around the exchange rate through full-scale intervention. Today's well-received move may just sway its decision.

The European Central Bank's move to test the waters to prop up the euro is sure to threaten the U.S. currency and result in higher interest rates. If the ECB launches a full-scale intervention, the dollar would become less attractive, causing bond prices to fall over fears the dollar would collapse. Indeed, the long bond is already down nearly 1 full point today.

Falling bond prices could cause a complete implosion in stocks (the Dow is already off 1.2% and the Nasdaq 3.1% for the week) as foreign investors begin to leave US dollar-denominated assets in droves. This could cause America's currency to crumble. Our best advice: Stay on high alert with all your investments, and be ready to take quick action.

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