For the euro zone, the fall of the dollar underscores the adage, "Be careful what you wish for." Europeans said they wanted a stronger euro, and now they're getting one. The problem is that a rising euro creates roadblocks for some European industries, and the Continent's calcified labor markets and enterprise-numbing regulations make it difficult to adapt quickly. So the usual drawbacks of an appreciating currency, such as getting priced out of export markets, will hit Europe faster and harder than they would Japan or the U.S. "We always said the fundamentals dictated a rebound of the euro," says Pedro Solbes, European commissioner for economic and monetary affairs. "But we're now worried that the change is happening too fast."
The euro's newfound strength--up 9% from its average first-quarter exchange rate against the dollar--is already taking a toll. German business confidence, as measured by the Ifo Institute for Economic Research index, took an unexpected tumble from May to June, from 91.6 to 91.3. Ifo economist Gernot Nerb says German manufacturers fear that the currency will rise too much, damping U.S. demand for their goods. Klaus Pohle, chief financial officer of pharmaceutical company Schering, for one, expects that a stronger euro will squeeze his bottom line. Carmakers are worried that the euro's strength and the dollar's weakness will hurt their sales abroad. "I have to say, a stronger dollar helps the business," says Hans-Olov Olsson, chief executive of Volvo Car Corp., which manufactures most of its cars in Europe and sells many of them in the U.S.
When the yen rose in the 1980s, Japanese companies speedily shifted production offshore and honed innovations such as just-in-time supply chains. When the dollar soared in the late '90s, U.S. export manufacturers were quick to shave costs by laying off workers and wringing out inefficiencies. But many European outfits already have moved a lot of production abroad and don't have the flexibility to cut costs by slashing Europe-based staff. "Strict employment protection laws mean euro-zone companies find it more difficult to respond quickly to changes in demand," says John Bowmer, chairman of Adecco, a large provider of temporary staff.
As a result, economists say Europe's anemic recovery will be even slower if the euro strengthens much more. A 10% increase in the currency's value has the same impact as raising interest rates by 65 basis points, monetary experts calculate. Some currency traders believe that the euro is still undervalued by up to 15% and is now set for a long-term upswing. Goldman, Sachs & Co. analysts are forecasting that the euro will reach $1.06 by this time next year, up from around 98 cents now, and that its rise will shave up to 0.7% off euro-zone growth this year. They predict that the economy will be lucky to expand by 2.4% in 2003. According to the Association of German Chambers of Industry & Commerce, the strengthening euro is "one of the factors that is strangling the economy."
Skeptics counter that so long as the euro doesn't suddenly go through the roof, all the scare-mongering will prove wildly overdone. Exports account for just 16% of the euro zone's gross domestic product, and only a fifth of them go to the U.S. And there is one immediate advantage of a stronger euro: It helps squeeze inflation by cutting the price of imports, especially oil. The euro's rise could help push European price increases below the 2% annual ceiling set by the European Central Bank, thus making a much-feared interest-rate hike unlikely.
Analysts eager to see more structural reform have a ready answer to European complaints about the stronger euro: Fix your labor markets, lower your costs, and stop whining. But whining is easier than reform.
By David Fairlamb in Frankfurt, with Christine Tierney in Stockholm