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Stand Aside or You May Get Hit by the Falling Euro

Thursday, 20 May 2010 11:57 AM Current | Bio | Archive

China’s assistant finance minister, Zhu Guangyao, made some interesting comments about the euro zone and the United States.

“The European sovereign debt crisis is a challenge not just for the countries that are party to it, such as Greece,” he said.

“In fact, it is a challenge to the stability of the entire international financial market. It concerns the recovery of the entire international economy, and so it demands a common response from the international community.”

Regarding next week’s U.S.-Sino bilateral meetings, he said that “we hope that the U.S. deficit will fall as a proportion of GDP as the economy recovers and reaches a sustainable level.”

Zhu said that currency policy would come up, but that such sensitive issues would be best handled only in “quiet discussions.”

Meanwhile, Bloomberg compiled 43 interesting forecasts on the euro-dollar relationship.

Charles Wyplosz, head of the International Center for Monetary and Banking Studies in Geneva, Switzerland, puts the euro’s long-term “fair value” at between about $1.10 and $1.20, as currency movements “tend to overshoot,” he said.

“My bet is that the euro still has ample room to go down before it goes up.”

Wyplosz’s view is shared by strategists at UBS, Danske Bank, Royal Bank of Scotland Group and Bank of America Merrill Lynch.

They predict the euro will trade at between $1.15 and $1.26 by the end of the year, while BNP Paribas said the euro may fall below parity with the dollar in the first quarter of 2011.

Credit Suisse Group AG strategists wrote in a note to their clients on May 18 that the euro may fall during the next three months to $1.16 as the sovereign debt crisis forces the European Central Bank to keep borrowing costs (interest rates) low.

History shows that the combination of tightened fiscal policy and looser monetary policy usually leads to a weaker currency and the euro probably won’t be the exception to the rule.

On the other hand, as an investor, I would start paying attention to what Joe Kaeser, chief financial officer of Munich-based Siemens AG and Europe’s largest engineering company, said in a May 18 conference call.

“In general, a stronger greenback is good. The super-competitive export machine of Germany is going to be compensated with a very, very weak exchange rate,” he said.

“You have a plus-plus situation on the profitability, especially for Siemens or the car industry. They will find a very profitable situation.”

We should keep in mind that 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.

This could mean that while the southern European “Club Med” countries are in dire straits, the northern euro zone exporters like Germany are bound for a non-negligible upswing in their export-oriented businesses that consequently should result in better profits.

I think that for U.S. exports, a weaker euro isn’t such good news because it implies U.S. exporters will face harsher competition because of the rising dollar.

We shouldn’t forget that U.S. exports helped lead the U.S. economic recovery as the dollar declined against all other major currencies last year, with the exception of the Chinese yuan.

U.S. exports contributed almost half to the 5.6 percent growth rate in the fourth quarter of 2009, according to U.S. Commerce Department data.

This year, since February, U.S. imports have been rising faster than U.S. exports.

Investors who want to diversify somewhat could take a look at euro-exporters, which could become interesting.

The fact that European leaders only seem to worry about the speed of the decline of the euro — and not so much about its lower exchange rate — could be a significant sign that they are comfortable with a euro at lower levels.

It might help to try and understand why the Europeans aren’t really upset by the euro’s actual lower exchange rate.

Yesterday, the euro was still about 5 percent overvalued on a purchasing power parity (PPP) basis compared to the dollar as calculated and daily communicated by the Organisation for Economic Co-Operation and Development, or OECD. (Purchasing power parity is a theory of long-term equilibrium exchange rates based on relative price levels of two countries).

The euro’s value is still higher than the weekly average rate of $1.1833 since its introduction in 1999. The euro’s all-time low was about 84 cents per euro in October 2000 and the peak was about $1.59 per euro on July 15, 2008.

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China s assistant finance minister, Zhu Guangyao, made some interesting comments about the euro zone and the United States. The European sovereign debt crisis is a challenge not just for the countries that are party to it, such as Greece, he said. In fact, it is a...
Thursday, 20 May 2010 11:57 AM
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