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Finding the Euro’s New Comfort Zone
May 20, 2010
Europe’s debt crisis only seems to escalating after it dropped to the lowest level since 2006 earlier today. For some members in the 16 country European Union this isn’t so terrible as an extended drop would benefit exporters in France and Germany. “The super-competitive export machine of Germany is going to be compensated with a very, very weak exchange rate,” said Redeker. “You have a plus-plus situation on the profitability, especially for Siemens or the car industry. They will find a very profitable situation.”
German exports account for almost half of the economy, making up 47 percent of gross domestic product in 2008, the latest year for which full data are available. It however, would likely derail President Barack Obama’s hope to double U.S exports within five years as American exports would have a hard time maintaining pricing competitiveness.
Charles Wyplosz is the head of the International Center for Monetary and Banking Studies in Geneva and has said “The euro depreciation is very good news for the region” because the rest of the world economy is expanding. This is going to bring a welcome boost that may save the euro zone from outright recession.”
Wyplosz has put the euro’s long-term “fair value” somewhere between $1.10 and $1.20, currency movements “tend to overshoot,” he said. “My bet is that the euro still has ample room to go down before it goes up.” Forex (normally this word could hyperlink to your site) traders have not seen such weakness in the Euro in many years and should be prepared for significant volatility brought on by the crisis in Greece.
Greek bankers in Athens have stated that even if Greece is unable to meet their debt obligations and is forced to reschedule interest and maturity payments, the country will continue to remain in the European Union and use the Euro. At this moment in time, a return to the Drachma is simply not an option. Ironically, it is the use of the Euro that facilitated Greece to borrow more money than it could service due to a host of problems including the enormous costs involved in hosting the Athens Olympics, the global recession and widespread tax evasion among its citizens.
Credit Suisse Group AG strategists wrote on May 18 that the euro may fall over the next three months to $1.16 as the crisis forces the European Central Bank to keep borrowing costs low.
The decline in the euro may hurt demand for the region’s sovereign bonds at the time when governments are issuing a record amount of debt. Standard Life Investments said on May 18 that it reduced holdings of European government debt, including German bonds, citing fiscal challenges and the tumbling euro.
“Countries in the euro region are bringing forward fiscal tightening and that reduces a chance of a swift and strong economic recovery,” said Richard Batty, a global investment strategist at the Edinburgh-based fund company, which has $175 billion of assets under management. “That hurts the euro. By buying euro-denominated assets, you are simply buying into the idea that the euro will remain stable.”
The $1 trillion lending backstop for indebted euro nations agreed to by European leaders on May 10 also won’t halt the slide because investors remain concerned about government debt, the growth outlook for Europe’s weaker economies and trade imbalances within the euro area, said Mansoor Mohi-uddin, chief currency strategist at UBS in Singapore.
The Frankfurt-based ECB probably will refrain from raising interest rates to help offset declining government spending in the region, Mohi-uddin said. “The combination of tightened fiscal policy and looser monetary policy historically leads to a weaker currency,” he said.
“Biggest Headaches”
Even so, pressure on the ECB to raise rates may grow as the euro’s decline feeds inflation by making imports more expensive. European inflation accelerated to a 16-month high in April, the European Union’s statistics office said May 18.
For European exporters, the euro’s biggest crisis since the monetary union’s debut is an opportunity after China overtook Germany as the biggest exporter of goods last year. Bayerische Motoren Werke AG, the world’s largest maker of luxury vehicles, gets almost a quarter of its revenue in North America. Shares in Munich-based BMW have gained 23 percent this year. Paris- and Munich-based European Aeronautics, Defense and Space Co., the maker of Airbus jets, last year called the euro’s strength at the time one of the company’s “biggest headaches.”
Munich-based Siemens AG, Europe’s largest engineering company, is also looking to benefit as it competes in 190 countries, according to Chief Financial Officer Joe Kaeser. “In general, a stronger greenback is good,” he said in a May 18 conference call.
Exchange Rate
“The super-competitive export machine of Germany is going to be compensated with a very, very weak exchange rate,” said Redeker. “You have a plus-plus situation on the profitability, especially for Siemens or the car industry. They will find a very profitable situation.”
Exports account for almost half of the German economy, making up 47 percent of gross domestic product in 2008, the latest year for which full data are available.
The biggest losers will be U.S. exporters that face a rising dollar, Barry Eichengreen, an economics professor at the University of California, Berkeley, said in a phone interview. “A weaker European economy is not good for us.”
Exports helped lead the U.S. recovery as the dollar declined against other major currencies last year, contributing 42 percent to the 5.6 percent growth rate in the fourth quarter of 2009, according to Commerce Department data. Since February, U.S. imports have been rising faster than exports.
While a cheaper euro may lure tourists to Europe, they may think twice about going to Greece, said Alan Ruskin, head of foreign-exchange strategy at RBS Securities in Stamford, Connecticut. He wrote in a note on May 13 that the euro could “easily head through parity” with the U.S. dollar.
“A weaker euro may help tourism in Greece. But on the other hand, a lot of people will be looking at the news and seeing Molotov cocktails flying through the air,” he said in a telephone interview. “That significant distraction could offset the benefit of a weaker currency.”
Concern by investors that the fiscal crisis will drag on and deficit-cutting in Europe’s biggest economies will undermine growth is keeping pressure on the euro. Another financial rescue package may be “inevitable,” former Bank of England official David Blanchflower said in a Bloomberg Television interview on May 18.
Bringing down European budget deficits will take years. Greece’s government aims to lower the budget deficit from 13.6 percent of gross domestic product last year, more than four times the level allowed by the euro’s founding treaty. Spain, seeking to ward off Greek contagion, on May 12 unveiled the biggest budget cuts in at least 30 years to reduce the deficit to 6 percent of GDP in 2011 from 11.2 percent last year.
Germany, where Chancellor Angela Merkel is pressing other European countries to enforce fiscal discipline, plans to meet the deficit target of 3 percent by 2013 under a constitutional amendment that dictates cuts in government borrowing.
European policy makers are helping depress the euro with their strategy, said Stephen Jen, a managing director at BlueGold Capital Management LLP in London.
“It’s hard to say what the sufficient conditions are for me to be bullish on the euro, but a necessary condition is that Greece and Portugal reschedule their debt,” he said. “The longer the Eurocrats resist this inevitable outcome, the less credible and consistent they appear.”
Article by Bloomberg.com
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