The Euro and the Damage Done

♠ Posted by Emmanuel in , at 9/22/2007 01:16:00 PM
Put simply, the world economy is out whack. Yes, the dollar should be weak by any measure, but the countries that have borne the brunt of dollar weakness are not necessarily those which are running large current account surpluses with America (or in general). You've got your Asian countries pursuing mercantilist policies like China, India, Thailand that are busy trying to slow down inevitable dollar depreciation against their currencies. You've also got Middle East oil exporters that are making jillions of dollars with oil prices at current levels that still peg their currencies to the dollar. The end result? It's folks who for the most part "play fair" that are taking it on the chin. Case in point: the EU. Especially vulnerable are countries like Italy that compete in export markets with the likes of the Chinese. Let's just say not everyone is Euroland is a happy camper. From the International Herald Tribune:
Fears of an abrupt slowdown in Europe deepened on Friday, after the release of weaker-than-expected economic data and a new record in the euro's relentless rise against the dollar.

Europe's stampeding currency prompted a warning from the plane-maker Airbus that it might have to cut costs more than expected to restore its troubled operations to financial health.

"If the euro remained durably at $1.45, that would mean we have to find €1 billion in additional savings," Fabrice Bregier, the chief operating officer, said in an interview with a French radio station. The euro briefly traded at $1.41 on Friday morning before falling back slightly.

Airbus, which is controlled by France and Germany, is already in the midst of a radical cost-cutting campaign, forced by heavy losses on its A380 jet. Its voice is the latest in a chorus of complaints from French and Italian leaders that the strong euro could choke off European growth.

What concerns economists more, however, is a sharp drop in the monthly survey of purchasing managers in the 13-nation euro zone - evidence that the credit crisis that began in the U.S. mortgage market and infected British and German banks has now seeped into Europe's underlying economy.

An index of purchasing managers in the service sector dropped four points in September, its largest monthly decline ever, suggesting that commerce here is slowing faster than economists predicted.

"It's a bad surprise," said Thomas Mayer, chief European economist at Deutsche Bank. "All this talk of Europe not being really affected by the problems in the U.S. may have been whistling in the wind."

It is far too soon to speak of a recession in Europe, Mayer said. The European Central Bank has put off an increase in interest rates, possibly for the foreseeable future, and injected funds into the banking system to prevent the credit crunch from mutating into a broader financial crisis.

Still, the speed with which the turmoil in the financial markets has registered in the purchasing data alarmed economists. Most are busy scaling back their predictions for growth in Europe next year.

"It certainly got me nervous," said Erik Nielsen, the chief European economist at Goldman Sachs, who had already lowered his forecast for European growth in 2008 to 2 percent from 2.3 percent.

The record-breaking rise of the euro has injected another unpredictable factor into their calculations. Most European exporters have weathered the rally without complaint, having cut costs and hedged their exposure, either financially or by moving production to non-euro countries. But a noisy minority is starting to agitate, and political leaders, notably in France, have picked up their concerns, lobbying the European Central Bank to take steps to stem the appreciation of the euro.

"We hope the ECB, at its meeting in October, will examine the consequences and take appropriate action," the French finance minister, Christine Lagarde, said during a visit to China on Friday.

The ECB rejects such demands as political meddling, and it has responded in increasingly testy fashion to statements made by President Nicolas Sarkozy of France and his ministers.

In a speech in Paris on Friday, one of the bank's executive board members, Lorenzo Bini Smaghi, said, "In no other country do the political authorities make frequent and uncoordinated public statements about the exchange rate." It hurt the credibility of European monetary policy, he said.

Economists say the level of noise in each country is roughly proportional to its exchange-rate vulnerability. German officials, for example, have said relatively little about the recent rally. The exchange rate was not a central issue last week at the Frankfurt auto show, despite the heavy reliance of German carmakers on sales in the United States.

"There's no doubt that by any measure, the Germans are in much better position than the French," Nielsen said. "On unit labor costs, Italy has also done a better job than France."

Still, on Thursday, the Italian industrialist Luca Cordero di Montezemolo said, "The super euro worries us; we don't want to give anyone any lessons, but this could become a problem for exports."

Airbus is particularly vulnerable because it earns all its revenues in dollars and incurs about half of its operating costs in euros. That puts it at a big disadvantage to its U.S. rival Boeing.

Under its existing plan, Airbus plans to cut €2 billion, or $2.8 billion, a year in costs by 2010, through the sale of several factories and the elimination of 10,000 jobs. In his radio interview, Bregier said the cost-cutting plan was predicated on a euro exchange rate of $1.35.

Airbus has hedged enough of its dollar exposure through the end of 2008 that the dollar's swoon is not likely to have a major short-term impact, Rainer Ohler, the head of communications said.

"Our problem is what's going to happen in 2009 and 2010," Ohler said. "But nobody can predict what the dollar is going to do."

U.S. Treasury Secretary Henry Paulson said Friday that a strong U.S. dollar was in American interests [that's a good one, Paulson!], and that he was optimistic the U.S. economy would continue to grow this year, Reuters reported from Chelsea, Quebec.

"I feel very strongly that a strong dollar is in our nation's interest," Paulson said after a meeting with Finance Minister Jim Flaherty of Canada.