A strong euro could undermine the European economy

The euro exchange rate is at 1.38 dollars, or almost ten percent more than a year ago.

Although export companies are complaining, authorities are downplaying the dangers.

And wrongly so since Europe depends on the rest of the world to pull it out of economic stagnation.

The euro is strong. The single currency has in fact strengthened compared to the dollar. At 1.38 dollars, it’s at its highest level in two years. The effective euro exchange rate, accounting for the weighted average of the main commercial partners’ currencies, has followed the same upward trend.

Is this a problem? Belgian drivers aren’t complaining. Gas prices are at their lowest in the past two years, as we explained in yesterday’s edition.

European companies, on the other hand, are having a hard time absorbing the currency’s increased rate versus the dollar as well as many other currencies, which is penalizing them in relation to their foreign competitors.

In an ironic twist, while this unfavorable exchange rate change could weigh down the faint European recovery that is just starting to take hold, the authorities continue to minimize the risk.

Jörg Asmussen, member of the European Central Bank (ECB) executive board, recently stated that he had no “specific concern” regarding the euro exchange rate. The French Economic minister, Pierre Moscovici, doesn’t think that the euro is overvalued at this time.

Whom do we believe? And how do we explain the euro’s vigor? It is at best counterintuitive since a currency’s strength is in direct proportion to the good health of its economy.

“Several factors could explain the appreciated value of the euro,” says Philippe Ledent, ING Belgium economist. “In one sense, it’s the dollar that’s depreciating. The reasons for this reside in the United States.” It’s mainly due to the disagreement between the Republicans and Democrats over the budget, which continues to remain latent despite the truce, and also to American monetary policy.

“The Federal Reserve has suggested that it would begin to reduce its purchase of treasury bonds that they use to inject 85 billion per month into the American financial system, but it won’t be doing this for a while yet. To the contrary, it will remain ‘accommodating,’ much more so than the ECB. It seems that the funds flowing toward the United States mainly from emerging countries come back in part to Europe where the first fits and starts of the economic recovery have been observed. This has given the Eurozone financial assets and its currency a shot in the arm.

However, return of Eurozone growth is still just a dream. Many forecasters are expecting weak growth at best over next year, which would resolve only very slowly. The American economy is doing better, even if it’s in the midst of its softest recovery since the Second World War.

Europe has also yet to solve its banking problems, especially in the periphery of the Eurozone, or its related sovereignty issues. The clouds of uncertainty still loom over growth prospects and public finances in Greece, Portugual, Spain and Ireland.

“The fundamental data lean toward a depreciation of the euro around early 2014”, states Ledent. “In other words, the stronger currency will not survive the winter.

“All the same, it’s not without danger or consequence”, continues the economist.

Then why is the European Central Bank seemingly unconcerned?

“This is due to two opposing points of view,” explains Ledent. “The euro has been much stronger in the past. As a matter of fact, in 2009 and 2009, it was inching up to 1.60 dollars,” recalls the economist, who thinks that the euro is only slightly overvalued. The effective exchange rate was also higher at that time than it is today.

This is Jörg Asmussen’s thinking. In nominal terms and in real effective terms, which is more important, it is within the band we have seen for the last ten years,he stated late last week in the Il Sole 24 Ore daily paper.

In other words, keep moving, nothing to see here. Nor anything to do either, particularly since the ECB, thus the Eurozone, has no exchange policy. This is undoubtedly one of the single currency’s many anomalies.

“Exporters do not see it that way. They see that in the period of a year the euro has appreciated by ten percent. This equals their price-competition loss,” observes Ledent. However, Europe needs exports to feed the touted recovery…

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