Why Europe should stop whining
Forget fears that record-high valuation of the euro will hurt exports: all indications are that a strong euro means a strong Europe. Fortune's Peter Gumbel explains.
PARIS (Fortune) -- Ever since the dollar began to fall against the euro in 2002, a chorus of government officials, economists and business executives around Europe - from the CEO of Airbus to the Prime Minister of Luxembourg - has complained publicly and in near-apocalyptic terms about the greenback's decline. Their argument has been that the tumbling dollar makes European goods less competitive on world markets and thus poses a big threat to the European economy overall.
As the greenback's slide has accelerated in the past month, such warnings have grown ever more frantic. French President Nicolas Sarkozy told the United States in a speech to Congress last month that continuing monetary disorder could turn into "an economic war in which we would all be victims." Even Jean-Claude Trichet, the governor of the European Central Bank, chimed in last week, complaining about what he called "brutal" foreign exchange volatility.
It's undoubtedly true that the plunging dollar - since 2002, the buck has fallen about 40% against the euro - does cause some pain around Europe, and its especially abrupt decline in the past couple of weeks has put nerves on edge in corporate finance departments trying to hedge against the drop. But the dire predictions about the bigger impact are looking about as accurate as Chicken Little's claim in the children's fairytale that the sky is falling.
In fact, much of the available evidence suggests that a strong euro has done more good than harm for Europe. Far from weakening European competitiveness, it has hastened a major restructuring of industry that has enabled firms from L'Oréal to BMW to compete more effectively in worldwide markets. They and many others have focused on expanding in fast-growing markets at the same time as they have kept an iron grip on internal costs, and have racked up strong profits as a result.
Moreover, the existence of the euro itself, which is now used by 13 European Union countries, has sheltered the European economy from much of the foreign-exchange turbulence, since a big majority of E.U. commerce is now with other E.U. countries. And at a time when world prices for food, energy and a multitude of other commodities that are denominated in dollars are rising, the strong euro is actually helping to mitigate the inflationary impact.
The price of oil, for example, has risen almost five-fold in dollar terms since 2002, but "only" three-fold in euro terms. That's still a huge increase, of course, but less than it could have been. The evidence that best demonstrates the benefits of Europe's strong-euro policy is to be found in Germany, a country whose economy depends to a massive extent on exports, and therefore one that should be severely affected by the dollar's decline.
But Germany's foreign trade numbers actually tell a story very different from the sky-is-falling scenario: exports have been racing ahead and the nation has notched up record trade surpluses. Indeed, despite the plummeting dollar, in 2006 Germany's trade surplus was about 25% higher than in 2002, and on current performance, this year looks likely to surpass that.
How come? Because German exporters from car manufacturers to machine tool producers have realized that they cannot compete on price alone. So they have focused on quality, on marketing, on global expansion and on servicing their customers' needs wherever they are, even as they have sought to whack costs out of their system.
Olaf Wortmann, an economist at the German Engineering Federation, whose members - largely machine-tool manufacturers - have boosted production by a blistering 39% in the past five years, says the last time business boomed so strongly was back in the late 1950s. The firms' biggest problems these days, he says, aren't caused by exchange rates but by production bottlenecks - currently, the industry is running its plants at 92% capacity. "All the talk about currency 'pain thresholds' is rather tiring," Wortmann says. "Of course the declining dollar does hurt, but it is overshadowed by many other positive factors." In particular, for German machine-tool companies, the strong demand from Russia, Chile, Canada, the Middle East and other places with strong natural resource sectors.
Will that story line continue? The latest data for the euro countries released this week shows that economic growth actually picked up in the third quarter. The eurozone economy is currently growing at an annualized rate of 2.6% - stronger than forecast and far better than almost any other quarter of this decade. As usual, economists are warning that there are big risks ahead, including the slowing U.S. economy, business uncertainty about the credit market problems and, of course, the falling dollar.
Olivier Gasnier at French bank Société Générale, for example, says he expects exports to be "far less dynamic" in coming months because of weaker international demand and "a loss of competitiveness triggered by the euro appreciation." That may be so, but as the European Commission pointed out in its latest economic forecast, while there are some signs that growth may be peaking, "the economic sentiment indicators remain well above their long-term average." Its conclusion: we should expect "relatively firm real GDP growth in the coming quarter."
The one area of real concern in Europe relating to currencies is the Chinese yuan, which is roughly pegged to the dollar. The E.U. has been running a robust trade surplus with the United States, notwithstanding the greenback's decline, but its trade with China is looking ever more lopsided. Last year, its deficit with China hit $185 billion. Like the United States, European governments are now trying to put pressure on China to revalue its currency. Later this month, a delegation of officials including the ECB's Trichet and the E.U.'s two top economic policy officials, Commissioner Joaquin Almunia and Luxembourg Prime Minister Jean-Claude Juncker, will travel to China to apply the pressure in person.
"China must come to grips with the idea that an undervalued currency is not only damaging for the global economy, and in particular for Europe, but also that it does not serve China's domestic interest, with inflation and excessive liquidities becoming an important problem for them," Ernst-Antoine Seillière, who runs Europe's main business lobby, said this week.