Euro Plunges To Lowest Level Since Lehman Crisis As Break-Up Worries Mount

05/14/2010 02:53 pm ET | Updated May 25, 2011

WASHINGTON — The euro sank to near a four-year low against the dollar Friday on renewed worries over the European debt crisis. The stronger dollar could spell trouble for a U.S. economy still recovering from a deep recession.

A stronger dollar against the currency used by 16 nations in Europe would translate into cheaper European vacations for American travelers. But it would hurt U.S. exports because American-made products would be more expensive in those markets.

The euro slid to a 19-month low of $1.2355 in late trading in New York, close to what would have been the lowest point in four years against the dollar.

Economists said the tumbling euro could reflect fears that the European debt crisis will turn into a replay of the Lehman Brothers disaster. The collapse of the New York investment bank in September 2008 spread panic through the financial system. Credit froze as a result.

"If this turns out to be the same kind of financial crisis that we saw after Lehman Brothers where people just get scared to lend money to anybody, then it would be a major problem for us," said David Wyss, chief economist at New York's Standard & Poor's.

The euro's slide seemed to be triggered by intensified worries over a nearly $1 trillion rescue package to deal with European debt problems. The European economy was already facing weak growth this year. Investors fear that if interest rates spike and countries slash spending further, the region could fall back into recession.

That fear gripped Wall Street for a second straight day Friday. The Dow Jones industrial average sank 163 points, or 1.5 percent, and broader stock averages fell even more.

"Europe was just barely growing before the debt crisis came to a head, and it is hard to see how many of those countries keep from falling back into recession," said Mark Zandi, chief economist at Moody's Analytics.

The euro-zone countries account for about 15 percent of total U.S. exports. Weaker growth in that region, along with the stronger dollar, would reduce demand for U.S. exports. The U.S. manufacturing sector, led by rebounding exports, has been a bright spot for the U.S. recovery.

Still, dimmer prospects for Europe could be offset by continued economic rebounds in Asia and Latin America, analysts noted.

Brian Bethune, a senior economist at IHS Global Insight, forecast that the European debt problems will keep pushing the euro lower. It's likely to hit $1.17 against the dollar this summer, he said.

U.S. interest rates will likely decline as foreign investors shift money out of European debt and into U.S. bonds, he said. The European crisis has already pushed mortgage rates in the United States down and helped sustain the housing rebound in this country. The average 30-year fixed-rate mortgage fell this week to the lowest point since December.

Oil and other commodity prices have fallen as well, a response to the stronger dollar and weakness in Europe. This will help keep inflation low in the United States. It will also give the Federal Reserve more reason to delay raising interest rates, another plus for U.S. growth.

"With a higher U.S. dollar, lower crude oil prices, that assures the Fed that there is no inflation lurking in the weeds," Bethune said.

The emergency financing deal sealed last weekend initially pushed the euro above $1.30. But concerns over the cost to European countries and the impact on the continent's growth have weighed on the currency since.

Greece, Spain and Portugal are raising taxes and cutting government spending to control their debt. That could halt their recoveries and slow growth in Germany and France.

"People are still very worried about longer term solvency issues for euro," said David Gilmore of Foreign Exchange Analytics in Essex, Conn.

In an interview published Friday, European Central Bank President Jean-Claude Trichet dismissed suggestions that the bank's decision to buy government bonds of indebted countries might stoke inflation. Higher inflation decreases the value of a currency. It can also prompt central banks to raise rates.

"The euro is in a no-win situation at this point," wrote currency strategists from Brown Brothers Harriman in a research note.

Future growth in Europe could be constrained if investors feel shaky about the banking sector's stability and willingness to lend, said Robert Sinche, chief strategist at Lily Pond Capital Management LLC in New York.

That could spread beyond the continent.

"The disintegration of the European currency could be very shaky for markets globally," said Brian Kim, senior foreign exchange strategist for UBS AG.

But for many trackers of currency markets, that's not a realistic concern. The European monetary union itself is not at risk, said Michael Woolfolk of Bank of New York Mellon.

"Talk of the implosion of the eurozone itself is, I think, overblown," he said. Even if heavily indebted countries such as Greece or Portugal left the 16-nation union, the common currency's union would end up stronger, he said.

U.S. Treasury Secretary Timothy Geithner rejected a suggestion made by former Federal Reserve Chairman Paul Volcker in speech on Thursday that the world could be facing "the great problem of the possible disintegration of the euro."

Asked about that comment, Geithner said Friday that he disagreed with Volcker. "I think Europe has the capacity to manage through this," he said in an interview broadcast by Bloomberg Television.

The euro has tumbled more than 15 percent against the dollar since the year began.

Other European currencies slid as well. The British pound fell to $1.4560 from $1.4643 late Thursday. The dollar rose to 1.1308 Swiss francs from 1.1147 francs.

The dollar was higher across the board against emerging-market currencies in Latin America and Asia where investors sought safety in the U.S. currency. It also gained against the Nordic currencies and the Canadian, New Zealand and Australian dollars.

The dollar fell to 92.21 Japanese yen from 92.84 yen. The low-yielding yen is also considered a safe-haven purchase.

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Arbel reported from New York.

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