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Weaker euro could boost European economy

If it happens gradually enough, the slide in the euro's exchange rate could help exports and provide the boost Europe's troubled economy needs.
/ Source: The Associated Press

How low can the euro go? Many economists think the 16-country currency is headed for a significant decline because of Europe's government debt crisis.

Some are even predicting that by next year the euro will sink to what's called parity against the U.S. dollar — €1 equals $1, a level last seen in July 2002 and an 18 percent slide from Friday's $1.23.

Such a decline would take some of the shine off Europe's vaunted project in a shared currency. And it would cut European's purchasing power for imports. But if it happens gradually enough, the slide in the euro's exchange rate could help exports and provide the boost Europe's troubled economy needs.

Export-focused companies would be more competitive on price outside the eurozone, likely boosting their revenue and helping to remove the threat that Europe will drag down the global economy and stock markets.

With a lower euro, Parisian hotel owners could sell more Left Bank hotel rooms to tourists from North America, while Italy would surely sell more shoes and textiles. And Spain just might be able to turn over some of that vacant seaside property left from a U.S.-style real estate bubble.

And since China and other Asian countries link their currency to the dollar, the euro would weaken in that direction as well and help trade with Asia.

All that would come as a relief to U.S. officials and investors, who have seen Europe's troubles weigh on stocks and expectations for the world economy in the past several weeks.

Exports have been a key factor lifting Europe out of recession. In the fourth quarter of 2009, exports from the eurozone rose 1.9 percent over the prior quarter and totalled €838 billion — or 36 percent of eurozone economic output.

Under pressure
That trend continues; the zone's exports rose 22 percent to €134.9 billion in March, up from €110.3 billion a year earlier, according to EU statistics.

European governments slowed the euro's the slide by agreeing on a €110 billion bailout for Greece and a backstop of up to $1 trillion for other indebted governments. But that has not erased longer-term skepticism remains about countries' ability to pay down heavy debts, or about whether all 16 members will remain in the euro. Many think Greece, which needed a bailout to avoid defaulting on a May 19 debt repayment, will eventually have to restructure by seeking more favorable repayment terms.

End of the year forecasts for the euro range anywhere from $1.15 to $1.22. One of those seeing $1.00 in 2011 is BNP Paribas currency strategist Hans Redeker.

"There are a lot of negative events taking place and that means the euro is going to stay under pressure for the time being," Redeker said. "But at the end of the day, we need a substantially undervalued euro to keep the euro zone together."

"That means a very weak euro is part of the survival strategy of the EU 16. We need a period of severe undervaluation of the euro."

Unicredit's chief economist Marco Annunziata sees a one in five chance of parity. "The standard argument is that it is not the actual level of the exchange rate, but it more the speed that the exchange rate moves that gets policy makers nervous," Annunziata said.

Commerzbank bank's outlook is for $1.22 by the end of the year — but said it could reach parity with the dollar if unexpected shocks hit the markets. "Experience teaches us that exceptional factors can have considerable effects," Commerzbank wrote.

Effect on austerity measures
A lower euro could help offset the dampening effects of spending cuts and tax increases already put in place or being considered by countries such as Greece, Portugal, Spain and Italy. These austerity moves are being taken to insure against the nightmare scenario where investors refuse to buy new issues of government debt in the weaker euro nations like Greece, Portugal, Spain and Italy, triggering default and an even larger decline in the euro.

Economists warn however that more than bailouts, more than cuts in spending, what the euro needs are structural reforms to get investors on their side. Those include stricter rules on controlling deficits so it doesn't happen again, and cutting the burdensome regulations on hiring and firing that discourage job creation — especially in the southern countries.

"It is very difficult to stop the slide until they can convince people that they can turn the economies on Europe's periphery to growth," Barcelona-based independent economist Edward Hugh said. "Investors are increasingly taking the view that the more difficult it is to return these economies to growth, the more difficult it is to hold this together in its present form. No one wants to hold currency in economies that may not be stable."

Italian Premier Silvio Berlusconi acknowledged that when Italy had the lira instead of the euro, it would deal with trouble by letting its currency devalue.

That option isn't available due to euro membership. But IHS Global Insights Raj Badiani says Italy's getting just about the same benefits from the euro's slide, anyway.

The weaker euro is very good news for Italian firms as they trade outside the eurozone. "The current eurozone debt resembles a typical pre-euro crisis in Italy, which would lead to an inevitable sharp fall in the lira, helping to conjure up an export-led recovery in Italy," Badiani said.

At the other end of the economic scale, powerhouse Germany will get less of an export boost, because its products are more quality driven, and not as susceptible to currency fluctuations. But lower value-added goods such as textiles, apparel, shoes and light manufacturing may benefit most.

A euro value around $1.20, Badiani said, helps "Italian producers to compete more effectively both at home and abroad."