Nicolas Sarkozy visit Washington yesterday.  His message was very clear.  He said that that Americans can expect a more productive and fruitful relationship with France than we had with Jacques Chirac, his predecessor who seemed to decide to close down all contact with the US over differences related to Iraq policy.  Of particular importance, Chirac pledged his unconditional support for US policy towards Iran, and agreed that Iran should not have nuclear capabilities.

The press properly reported on this aspect of his trip, but failed to detail some of the other things that Sarkozy said. 

If you read the transcript of Sarkozy's speech to Congress, the message is clear.  While France and Europe want to have a productive trading relationship with the US, it is not possible so long as currency exchange rates are so far out of alignment with purchasing power parity.  US insistence of the continued and unabated collapse of the dollar will not be tolerated by Europe.  Europe cannot sell their products in the US anymore, and more importantly they will not allow US producers to benefit from the decline in the dollar to flood Europe with its crap.  Sarkozy was unequivocal - act now and act decisively to stop this unabated decline in your currency or we will immediately put up tariffs that will bar your products from entering the European Community.

Sarkozy is correct to be taking the stance that he is taking.  He is the head of Europe's second largest economy and he is trying to transform it from a nanny state back into a competitive economy.  He can't do that when the European currency is so strong that the playing field is tilted against him.

I believe that Sarkozy's message is very similar to the message coming out of China and the message that has been coming out of Germany for some time.  The US decision to drop the dollar has been a travesty for our trading partners and our government needs to reciprocate by stopping the decline.

Most importantly, this decline in the dollar has not benefited us.  It has already caused a dramatic diminution in the value of our earnings and our savings.  If not reversed immediately, it will further contribute to dramatic inflation that will be a much bigger economic problem than anything else that we are facing.   Our government has relied on rising housing prices, cheap borrowing and cheap flat screen TVs from China to keep the American consumer happy.  The assumption that any rise in imports from a weaker currency will offset the fall in the GDP from housing declines should be thrown out the door now that are trading partners are threating sanctions.

Most important for the Paulson, the dollar's decline has been so sudden and so dramatic as a result of Bernanke's dumb move to cut interest rates to try to bail out the banks that it is now having a cascading effect.  Capital is leaving the US quickly since interest rates are so low whereas it should be coming in because the dollar is so low.

While driving the dollar back up will hurt the earnings of some major US exporters, it will help stabilize the major money center banks immediately and it will lessen the fall that our stock market would otherwise take from continued capital outflows from the US.

Bush has had a series of dreadful Treasury secretaries who have caused the current problem.  Paulson now needs to act decisively and announce that the Treasury is buying dollars.  That will drive out the hedge funds and immediately drive the currency towards the 1.30 to 1.35 level.   He should put his Goldman Sachs hubris aside and listen to others for once.  Not to do it would be irresponsible.