Nobel laureate Mundell: Euro gains risk deflation

By Steven C. Johnson and Kevin Plumberg

NEW YORK, Sept 4 (Reuters) - The euro's steady appreciation against the dollar in the last several years threatens to devastate the European economy by tipping it into deflation, Nobel Prize laureate Robert Mundell said on Tuesday.

Speaking at a forum in New York organized by Brown Brothers Harriman, Mundell said the euro's march toward $1.40, which began gathering pace in 2005, threatens to lead the euro-zone down the path traveled by Japan after the 1985 Plaza Accord.

That's when Japan agreed to let the yen rise, with the dollar at one point slipping to as low as 80 yen from around 240. The move crippled Japan's export industry and sent the country into more than decade of deflation.

Mundell, who won the Nobel Prize for Economics in 1999 and is often credited as the intellectual father of the euro for his research on optimal currency zones, said the same could happen to Europe's economy.

"The movement up in the euro toward $1.40 is devastating for the European economy," he said. "It creates the potential for deflation ... it's a hangover for the stock market."

The euro's climb has not come only at the dollar's expense. Adjusted for inflation and weighted by trading partners, the euro has broadly risen 20 percent in the last 5-1/2 years.

The euro zone economy grew at an annual rate of 2.5 percent in the second quarter of this year, the slowest pace since the first quarter of 2006.

Particularly troubling, he said, has been the euro's resiliency during the current credit crisis set off by mounting defaults on assets backed by risky U.S. mortgages.