PLAY OF THE WEAK

SYNOPSIS: It's time to stop the freefall of the Euro

Alas, poor euro! Europe's new currency, proudly introduced less than two years ago at a value of $1.17, has fallen to a humiliating 85 cents. And things look rotten in the state of Denmark, where next week's referendum to be or not to be part of European monetary union, that is the question looks likely to result in defeat for the pro-euro forces.

Over the weekend, when finance ministers from the major industrial nations meet in Prague, the slumping euro will surely dominate the discussion. Europeans would very much like the United States to join them in intervening that is, buying euros and selling dollars to drive up the euro's value. By all accounts, America won't go along. But it should.

Let me admit that I have come around to this view only with great reluctance. As a general rule, big economies like the United States or the European Union can and should be relaxed about fluctuations in exchange rates; I regarded the wailing as the euro sank from $1.17 to $1 as much ado about nothing. Furthermore, attempts to manipulate currencies through intervention have a bad track record; they usually fail, and when they fail the currency and the credibility of the government plunge in tandem. (Prime Minister John Major tried to prop up Britain's pound in 1992; the embarrassing failure of that attempt is one of the main reasons Tony Blair is prime minister today.)

But there are times when general rules don't apply, and this looks like one of them. Yesterday Michael Mussa, chief economist of the International Monetary Fund, put it this way: "Circumstances for intervention are very rare, but they do arise. One has to ask, if not now, when?" Indeed.

Why is intervention usually a bad idea? Because foreign exchange markets are immense so immense that even a huge government intervention will be blown away if it tries to stand in the way of firmly held market sentiment. The Major government threw some $50 billion into the defense of the pound in 1992; the market, convinced that the pound had nowhere to go but down, swallowed that sum with hardly a burp, and the pound kept falling.

But sometimes a run on a currency is driven not so much by economic fundamentals as by herd mentality. When the herd is running, there is a case for what people at the Fed call "slap in the face" intervention. Basically, by ostentatiously buying a currency that is plunging for no good reason, the authorities pull investors up short, forcing them to consider if they really want to bet against the finance ministries and the central banks. If all goes well the market in effect shakes its head, says "Thanks I needed that," and returns to its senses.

And the fall in the euro now looks very much like herd behavior. To justify the euro's current weakness you have to believe not only that America's "new economy" will keep delivering spectacular growth indefinitely, but that Europe will never experience a comparable surge of its own. And that just isn't plausible. The extraordinary weakness of the euro is possible only because investors, focused on the short term, have stopped thinking about tomorrow or maybe the day after tomorrow. That's exactly the kind of situation in which intervention is likely to succeed but probably only if the United States joins in.

Should we take that risk? No question, there are risks: The intervention might fail, damaging our own credibility; or it might succeed too well, sending the dollar into free fall. But there are also risks in not intervening.

America, after all, has some direct interest in seeing a more reasonable euro: the weakness in Europe's currency has reached the point where it is starting to hurt the bottom line of the many U.S. corporations for whom Europe is an important market. But the really compelling reason to help Europe now is to set a precedent. Despite its shambolic start, the euro is not going to vanish indeed, it will be one of the world's two great currencies in the years ahead. And while it may seem hard to imagine in these days of the almighty dollar, there will someday come a time when we would like the Europeans to support our currency. Let's do unto others now as we would have them do unto us then.

Originally published in The New York Times, 9.20.00