Everybody's talking at me.
I don't hear a word they're saying, only the echoes of my mind
-Harry Nilsson
These days it seems like everybody is talking at me about the strength of the Euro and the relative weakness of the U.S. dollar. As I wade through the opinion filled magazines and newspapers, I can’t help but wonder how Europe can cope with such a strong currency. Will this be long term? How will it affect Europe’s tourism market and its ability to export products? Will consumers in the U.S. see increased prices? As European firms grapple with a weak U.S. dollar, it begs the question: what impact this situation will have on the world stage?
Not only is a strong Euro affecting consumers, it has already had an impact on many European countries and their U.S. dollar holdings. They have been reducing their dollar exposure, and while I don’t think there will be an exodus from the U.S. dollar as a reserve currency, this trend is concerning. Just last year, Sweden cut its U.S. dollar holdings to 20% from 37% of its reserves and eliminated its holdings in yen, formerly 8% of reserves. Formerly its holdings were about one-third each euros, U.S. dollars, and other currencies. As a result, Sweden now has a greater exposure to the European economy. And since 1998, the Swiss National Bank has been moving its reserves from U.S. dollars to primarily euros and sterling.
For many European industries, a strong Euro could hurt growth. The increasingly feeble U.S. dollar and the mighty Euro are forcing Europe’s tourism, aeronautics, automobile and fashion industries to cope in an unstable market.
The industry to take the biggest hit would likely be Europe’s tourism industry. With such an unbalanced exchange rate, many Americans cannot afford travel to Europe. In the United Kingdom in particular, a visit across the pond means a dollar is really worth about 50¢. Or for Yankees considering traveling to France, Germany or one of the other 11 European Union countries that use the Euro, the dollar is currently worth about 73¢. These are compelling reasons for Americans to take a closer look at destinations such as Hawaii or Puerto Rico or even Fiji, New Zealand or Australia, where the U.S. dollar still reigns.
But tourism is not the only European industry that stands to suffer from a high euro; manufacturing may catch a case of the blues as well. March saw the long waited arrival of the new Airbus A 380 super jumbo. The production of the A380 had been plagued by delays, it’s now two years overdue, and has contributed to billions of dollars in losses at Airbus's parent company, Europe's EADS. With the Euro being so strong, the company is finding it difficult to turn a profit with the new plane. This has lead to discussions of layoffs and restructuring that have sparked animosity across countries within the European Union. Newly elected French President Nicolas Sarkozy has explicitly tied the difficulties of EADS to the high valuation of the euro, saying, “A weaker Euro should be a tool to help European industry… Ten cents of appreciation on the euro is a billion euro deficit for Airbus. We didn’t create the euro in order not to make a single plane in Europe.”
Even Bayerische Motoren Werke (BMW), the world's largest maker of luxury cars, released information that first-quarter profits plummeted 38% because of a stronger euro. The Munich-based company, whose largest single market is the United States, expects higher raw material costs as well as a rising euro to continue to impact earnings this year.
European fashion designers are also determining if they should raise prices due to the decline in the U.S. dollar. Versace, Armani, Christian Dior and Dolce & Gabbana all are faced with the challenge of maintaining competitive in a soft U.S. economy.
And in France especially, a weak dollar stands to have a damaging effect on an already weak economy. Newly elected French President Nicolas Sarkozy has been urging the European Union to develop a coordinated economic strategy to protect its citizens from globalization and to retain its popular legitimacy. Sarkozy has been arguing for the reworking of the European monetary policy, something he has blamed for eroding the competitiveness of French industry. Sarkozy is pushing for the weakening of the Euro by the European Central bank in an effort to stimulate economic growth, rather than simply focusing on combating inflation.
There is some concern that life could become harder for the ECB in the second half of 2007, particularly if the incoming French government continues to criticize it. The Euro zone economic growth continues to show signs of slowing and the euro appreciates further against the USD. France’s February unemployment rate decreased 0.1% from the previous month to 8.4%, a 1.1% drop from the same month in 2006. Sarkozy is looking improve that rate as he takes office.
The strength of the euro also serves as a source of contention between the members of the Union. While this strength as served some countries well and served to bolster the economies of other, it has affected the quality of life for other E.U. members and not always in a good way. With this in mind, all eyes will be turning to Sarkozy this June to see how he handles France’s position regarding the E.U. treaty. France has purposely stayed on the sidelines for the last couple of years and it is apparent to many that the E.U. cannot function optimally without France fully engaging.
In contrast, German productivity has reached record levels, primarily in exports. Germany’s March jobless rate fell 0.3% from the previous month to 9.8%, its lowest level since December 2006. The rate fell 2.2% from the same month a year earlier.
And the UK’s fourth-quarter GDP increased 0.8% from the previous quarter and 3% from a year ago. Preliminary numbers for the first quarter show a 0.7% rise compared to fourth quarter 2006 and a 3% increase annually. Unemployment in the region for the three months ending February 2007 increased 0.1% to 5.5% from the previous three-month period, and rose 0.3% from the same period a year earlier.
Some financial analysts believe that the rapidly appreciating euro would make Euro zone products more expensive and less competitive on overseas markets and as such could threaten the Euro zone’s economic rebound. European products could just become too expensive and could damage its export market. A strong euro does undermine the competitiveness of Euro zone goods on international markets and could potentially cut foreign demand, which has been a supporting factor for Euro zone growth.
What concerns all economic analysts is the risk that if the imbalance of the U.S. dollar to the euro continues to build, there could be a sudden correction with destabilizing effects. What goes up will come down, right?
So, can Europe cope with a strong euro? Only time will tell. A euro worth more than $1.40 would not just be an issue for manufacturers or exporters, it would be an issue for everybody. It is true that Germany and other countries that are closely linked economically have the ability to withstand the pressure of an expensive euro, but Mediterranean countries such as France, Spain and Italy probably cannot. Those countries should be hoping to see the market stabilize and correct itself soon. All this must be taken with a grain of salt however. Analysts and economists have been speculating about the euro since its inception. Do a quick Google search and you will see these same issues bandied about since 1999, regardless of the euro price.
As for me, I will take the advice of Harry Nilsson and I’m going where the sun keeps shining through the pouring rain, going where the weather suits my clothes. And while I am there, I will watch with interest what happens next in the ever-evolving euro story.
Marilyn McDonald is an author and foreign exchange trader. She can be reached via her website at www.marilynmcdonald.net.
