UK and US exports

Gewaltig (2008) demonstrates the scope of the Euro’s rise against the US Dollar, showing that in February 2008 the Euro had increased by 12% year on year against the dollar. This was on the back of 9.1% increase in 2007 and an 8.2% increase in 2006. The most significant change in the value of the Euro versus other countries’ currencies is that it can make exports less competitive in foreign markets, and hence reduce the level of demand for them. Indeed, with many of the world markets trading in dollars, such as the commodity markets, this could have serious impacts on the competitiveness of the Eurozone economies, particularly due to their focus on trade.

Gewaltig (2008) also examined a report from the European Union which indicated that, due to the unique nature and specific characteristics of some of the exports from the EU, such as French wine and German automobiles, the export demand was likely to be relatively insensitive to any such changes in the exchange rates (Gewaltig, 2008). However, the Economist (2008) reported that the several years of steady growth maintained by the EU was likely to result in a downturn in the near future, because of the growing strength of the Euro and the lack of competitiveness of many exports.

Indeed, Scott (2007) reported that EADS, the European airspace corporation which own Airbus and many other businesses, specifically targeted the strength of the Euro versus the dollar as a potential business threat. The companies figures showed that for a ten percent rise in the value of the Euro against the dollar, the company would lose one billion Euros in operating profit as a result of the increased competitiveness of Boeing; its main competitor which trades in dollars. As such, it is clear that the growing strength of the Euro is harming the strength of exports from the Eurozone and, according to Wolf (2008), the overall economic growth of the Eurozone versus the UK.

However, another significant impact of the strength of the Euro comes from one of the main causes behind said strength. This is the fact that the European Central Bank has made very strong statements about its commitment to fighting inflation, whilst the US Federal Reserve and the Bank of England have both cut their key lending rates in a bid to boost their economies in the face of the global slowdown (Cohen, 2007). Whilst this has led the Euro to strengthen against other currencies, it has also helped to control some of the internal sources of inflation in the Eurozone economies.

This has meant that, whilst trade unions in Britain and the United States have begun demanding higher rates of pay in order to cope with current and likely future inflation due to the interest rate cuts, the Eurozone has maintained somewhat lower inflation expectations. Whilst this has not significantly affected the inflation in the Eurozone economies at the moment, with the majority of the inflation being driven by global commodities, it may help keep the Eurozone inflation rates lower in the future (Economist, 2008).

A further impact of the strength of the Euro is that, whilst exports will become more expensive, imports will become more affordable for precisely the same reason. This is particularly important for commodities such as oil and gas, which are traded on the global markets in dollars. Whilst it can be argued that a significant proportion of the current rise in the price of these commodities is due to the weakness of the dollar, and hence their prices in absolute values will not have changed due to this, there is also increased uncertainty around the supply of these commodities, coupled with rising demand and increased speculation (Wallace, 2008). Whilst this rise in commodity prices has hurt consumers in the Eurozone, they have been less affected than consumers in the UK and US, as the stronger Euro has helped to absorb some of these price rises. In addition, goods imported from the UK and the US into the Eurozone will now be cheaper thanks to the strength of the Euro versus the pound and the dollar.

However, the National Institute Economic Review (2005) argues that this combination of decreasing export strength and increasing import strength is arguably the worst possible for the fiscal balance in the Eurozone. This is because economic growth in the Eurozone is weakening due to a need to attend to the many structural reforms and integration requirements discussed in the previous section.

This is compounded by the fact that the Eurozone is a net importer of commodities such as gas, oil and metals; and a net exporter of manufactured goods. The strength of the Euro thus means that the Eurozone economies are less able to export their finished manufactured goods to key markets, at the same time as the raw materials they use to create these manufactured goods are rising. In addition, the fact that the Euro has performed best against the pound and dollar means that UK and US exports to the Eurozone are growing in competitiveness versus domestic goods. With the National Institute Economic Review arguing that Eurozone domestic demand is likely to continue to grow slowly, and consumption may decline, the Eurozone is arguably entering a very difficult period. This will be exacerbated by the fact that governments are unable to adjust their own interest rates, and their public sector expenditure is constrained due to the Stability and Growth Pact which is part of Euro membership.

However, it is important to note that, paradoxically, some of the Eurozone nations have benefitted from this, particularly the weaker nations. OCED Observer (2004a) presents predictions for the Italian economic, which argue that the growth in the level of exports and investment activity will tend to rise due to the strength of the Euro. This is because Italy has been forced to make several competition reforms to key sectors of its economy, which has helped to make Italy more competitive and innovative relative to its Eurozone partners. This additional competitiveness is now coming to the fore, whilst other nations struggle.

In contrast, in another article, OECD Observer (2004b) points out that Ireland’s strong growth in previous years has led to excess demand, which has begun pushing up inflation rates. As such, the Irish economy is more vulnerable to the strength of the Euro, as it has not focused on driving efficiency and competitiveness during its rapid growth. Indeed, the strong Euro combined with the lack of flexibility in the Irish economy is arguably one of the reasons why Ireland has gone from being the ‘Celtic Tiger’, to arguably being included in Smith’s (2008) underperforming ‘PIGS’.

In conclusion, the unique nature of the Euro, as a single currency operating across different national economies with different national legislation, means that the impact of a strong exchange rate is somewhat different than the impact on other countries. Whilst the Eurozone is experiencing the usual loss of competitiveness of its exports, and increasing competitiveness of imports, the diverse nature of the national economies is helping to mitigate this in some areas. In addition, the strength of the Euro has assisted structural reforms in countries such as Italy, whilst exposing structural weakness in nations such as Ireland, thus having a dynamic impact on the distribution of wealth and competitiveness inside the Eurozone.

References

1. Askari, H. and Chatterjee, J. (2005) The Euro and Financial Market Integration. Journal of Common Market Studies; Vol. 43, Issue 1, p. 1-11.

2. Barrell, R. and Weale, M. (2003) Fiscal Demand Management. National Institute Economic Review; Issue 185, p. 5.

3. Cohen, A. (2007) Euro’s Rise Is Set to Spark Some European Fireworks. Wall Street Journal – Eastern Edition; Vol. 250, Issue 82, p. A2.

4. Economist, The (1998) The merits of one money. The Economist; Vol. 349, Issue 8091, p. 85-86.

5. Economist, The (2008) Too good to last. The Economist; Vol. 387, Issue 8580, p. 63-64.

6. Gewaltig, N. (2008) The Euro’s Rise: Don’t Expect a Rate Cut. Business Week Online; 14th March 2008, p. 25.