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Bush Should Talk to Europe's Investors

By Felix G. Rohatyn
Tuesday, January 4, 2005; Page A15

President Bush's trip to Europe next month has been billed as an effort to reach out to our European allies and restore some of the relationships fractured by the war in Iraq. But there is an even more urgent matter for the president to deal with -- namely, restoring European confidence in America's ability to continue to manage the global financial system. It should be our first priority.

Bush's schedule will be filled by official meetings with political leaders, military leaders and bureaucrats, as is the case for all presidential visits. Yet it's hugely important that, as part of this trip, he request time with Europe's leading business executives. Not only are they America's best friends in Europe at a time when hostile opinions of the United States are still running high, they are also critically important to our economy and our well-being.

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All the attention being lavished on China and India does not change the reality that Europe and the United States are one another's largest trade partners, largest investors and largest employers. This is particularly important to note at a time when we require $2 billion per day of foreign capital to service our debt, when the dollar is losing value regularly in the marketplace, and when the overall net flow of foreign money into American stocks and bonds has fallen sharply.

As of the end of 2002, Europe's net direct investment in the United States amounted to approximately $1 trillion; this consists of fixed, long-term assets such as factories, real estate and other businesses. Current valuation would be substantially higher. Other European holdings consist of portfolio securities of various types; they are quite liquid in nature and can be bought or sold in large amounts and on short notice. As of June 30, 2003, European holdings of U.S. equities amounted to $816 billion, and long-term debt securities, including U.S. Treasury bonds, amounted to just over $1 trillion. While Asia's holdings of U.S. long-term securities are approaching Europe's, Asia's level of equity ownership is still only 30 percent of Europe's, and, by and large, Asian financial institutions are less likely, for political as well as economic reasons, to be large-scale sellers of U.S. securities. The same constraints would not apply in Europe.

Economically, Europeans view their investments in the United States through the prism of the significant devaluation of the dollar. If one were to assume an average of only 30 percent devaluation of the dollar vs. the euro (as opposed to the current 40 percent or more), present-day portfolio losses for the Europeans due to dollar devaluation would be in the hundreds of billions of dollars. Europeans are skeptical about our mantra that "the United States is for a strong dollar" as well as about our commitment to deficit reduction, since, as a practical matter, the Treasury and the Federal Reserve have acquiesced in a policy of cheap money and high deficits. Europeans would, however, strongly support Bush's call for tort reform. Many European companies are facing devastating lawsuits in asbestos cases in the United States, and capping these liabilities would be an important incentive for them to continue to invest here.

"Credit" comes from the Latin "credere," to believe. European investors have to believe that we are serious about dealing with our own as well as the world's financial instability. The first step would be a firm presidential commitment to a strong and stable dollar and budgetary policies that are consistent with that commitment.

Many European business leaders are concerned when it comes to the Bush administration's economic policies. While they have admired our ability to recover from the stock market crash, the recession and the impact of the terrorist attacks of Sept. 11, 2001, they are dismayed by the level of our budget deficits, by the weak dollar and by our inability to contain our foreign debt. As a result, they are likely to be concerned as well about current proposals to increase the national debt by $1 trillion to $2 trillion as part of a Social Security fix, and they may need convincing that tax reform will lead to lower budget deficits in the coming years. The president's economic team should not simply dismiss their views.

But European business leaders strongly agree with Bush that better European growth is needed to solve many of these problems, and they would encourage their governments to commit to more aggressive economic growth policies and a greater level of investment in defense. That is in our common interest, and they should be encouraged to do so.

In our constant assertion of global power, we must not overlook our significant vulnerability to financial destabilization. Capital is power, and we no longer have a monopoly in that regard. Nor is who did what in the war in Iraq a major factor here. As an example, the combined holdings of U.S. securities by the so-called New Europe -- i.e., Poland, the Czech Republic and Hungary -- which supported us, totaled about $16 billion in June 2003. Those of France and Germany, the so-called Old Europe, which opposed us, totaled nearly $250 billion.

"Never risk what you can't afford to lose" is a basic rule of business. Our economic policies of a rapidly growing external debt coupled with a weak dollar and relentlessly growing domestic budget deficits are creating the risk of a global dollar crisis. The Europeans have a large stake in this game; we should keep their objectives aligned with ours. Their business leaders have been among our strongest and most consistent supporters, and whether we like it or not, we need them. We want them to be confident investors in the United States. If they were to reduce their holdings, the result would be a weaker dollar, higher interest rates and significant pressure on our markets. That is clearly not in our interest.

President Bush has a perfect opportunity to recognize that fact, treat Europe's business leaders as partners and help to stabilize a dangerously fragile global financial system.

The writer, an investment banker, was U.S. Ambassador to France from 1997 to 2000.

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