Decline of the Dollar: Low dollar, high pain for Europe

Posted December 5, 2007

"Some high-carat European economists see the potential for an exchange rate of up to $1.60 per euro, which would mean another 10% devaluation from current levels. This would cost the European economies another half percentage point in economic growth." — J. Christoph Amberger

by J. Christoph Amberger

Baltimore — (TFN): Open your email any given day now and you’ll find reams of e-letter rants predicting the impending disappearance of the U.S. dollar and, by default, the United States as an economic and financial superpower. Sure, the dollar is now near or even past the exchange rate lows it posted in the 1990s against the Deutsche Mark, which is the most comparable currency for apples-to-apples long-term exchange rate comparison.

But what happens if the increase of the euro’s valuation, not just against the dollar (and thus, yuan) but also against the yen, collides with cooling global demand and a slowdown of the global economy?

The rising euro and hence, the relative rising cost for European labor, are already taking a healthy bite out of the margins of European manufacturers. Look at BMW and Airbus. European economies may be seeing strong investment activities and solid export numbers… but falling private consumption (in a year of economic expansion no less!) indicates that exports remain the keystone to their economic well-being.

Too busy to read? Just click here to listen!

Some high-carat European economists see the potential for an exchange rate of up to $1.60 per euro, which would mean another 10% devaluation from current levels. This would cost the European economies another half percentage point in economic growth. While manufacturers and exporters still are sitting on solid order backlogs, it remains to be seen if orders keep coming in when exchange rates alone are adding a 10% premium to European products… not to mention the increase in labor cost that typically follows high-publicity strikes like the ones in France and Germany right now.

Give it some time and you might get an instant replay of the wave of cost cutting we saw in 2003 and 2004, when the euro passed the $1.30 mark. Which will further reduce already anemic domestic demand.

Of course, the defined mission of the European Central Bank is "maintaining price stability." So far, it has been trying to achieve this with mixed results by keeping interest rates high and credit expensive – and by complaining to Beijing and Washington. Beijing is supposed to let the yuan float. That would make Chinese labor and exports more expensive, and Europe's goods and services more competitive.
The Chinese may find this quite very humorous. They've let the yuan appreciate – and might point out that now it’s Japan’s turn, which lets its currency fall unchecked – after actively devaluing it for years.

Of course, they have a point: Maintaining price control is a mandate to act, not just a license to whine. European bankers are free to actively intervene any time – buy dollars and yuan and sell euros to their hearts' content, much like the Japanese have done.

But it's Europe, and blaming the United States for spending the global economy out of recession might just be more convenient.

****Make sure you sign up for our FREE TFN News Feed for breaking news, special reports and new financial videos. Click here to pick your favorite reader. If you prefer to have the feed delivered to your email, just click here.