When the euro was introduced in 1999 its exchange rate against the dollar was 1.1789. In July 2008 the euro/dollar rate went up to a massive 1.60. Most economists were predicting that quite soon the euro would replace the dollar as the world’s favourite reserve currency. Today the same economists believe that the euro will soon hit parity with the dollar.
So what is causing this massive volatility in the exchange rate of the common currency? Put simply, financial markets and investors have more faith in the ability of the US economy to grow without too much artificial help from central bankers.
Following the 2008 financial crisis, EU political leaders relied on the European Central Bank to rescue countries that were on the verge of bankruptcy because they were carrying too much debt and were unable to pay their creditors on time. Ireland, Spain, Portugal, Greece and Cyprus had to beg their way out of financial annihilation thanks to massive loans given to them by other eurozone countries.
The ECB relied on extended lax monetary policy to make this possible. Interest rates were reduced to historically low levels and quantitative easing was introduced on a massive scale by the monetary authorities. This has avoided a quick meltdown of the eurozone economies, but it has also brought an addiction to artificial support in the form of vast pools of liquidity that costs next to nothing for indebted countries to tap into.
Printing money to resolve debt problems is the dream of every debtor. Of course, in the lives of ordinary people such a solution does not exist, or if it does it could soon land the money printers in jail. But central bankers can legally print money to bail out distressed economies. Even so, such monetary wizardry has its limitations and many economists believe that printing money by central banks will in the long term prove ineffective to resolving the structural problems that some EU member states are facing.
With the US economy showing healthier signs of growth, the Federal Reserve is increasingly looking at increasing interest rates gradually, possibly even by the end of this year. When businesses can borrow money at artificially low prices, they may be able to invest in various projects that can stimulate immediate economic growth, but long-term growth will always depend on solid investment plans not artificially supported by monetary policy wizardry.
It is a question of time before EU businesses realise that a weak euro could only help them partially
The situation in the EU remains different. The ECB is committed to continue keeping interest rates low and is not shying away from printing more money to support struggling EU economies. The low price of oil is extending the breathing space for struggling countries and businesses who would almost certainly collapse if it were not for the artificial help made available by central bankers.
But the ECB has also warned EU politicians that monetary policy on its own will not pull the eurozone out of its structural problems. The old problems of lack of economic and fiscal unity are now being further complicated by the socio-political problems facing Europe. With millions of African and Middle East refugees knocking on Europe’s unguarded frontiers, the very future of Europe is being questioned by those who are not addicted to happy talk.
In the short term the depreciation of the euro will help established eurozone industries to become more competitive. The low price of oil will also boost our competitiveness, but it will be foolish to expect that these favourable conditions will last for long. Understandably, US businesses are generally worried about the strength of the dollar. With US presidential elections looming, political pressure will build up to protect US industry competitiveness by fair and not so fair means. It is a question of time before EU businesses realise that a weak euro could only help them partially.
Europe needs more structural reforms if it is to compete not just with the US but with emerging economies. We need to start by making the hiring of staff easier by liberalising the labour market and guarantee more flexibility to employers. What we are doing today is protecting those already in employment, but not doing much for the millions of unemployed many of whom are highly qualified.
We also need to look at our educational systems that were once the envy of the rest of the world but which today are often producing graduates who are unemployable.
A weak euro is just a symptom of an aging economic mindset.
johncassarwhite@yahoo.com