Restore Confidence In The Euro Zone

The European Central Bank is agonizing over what to do about the sinking euro. The single currency briefly hit an all-time low of 93.6 to the dollar on Feb. 29. The ECB is being blasted for weakening the currency with its inconsistent statements concerning policy. To shore up the currency, the central bank is under pressure to raise interest rates. It is also hinting that it may intervene in the currency markets.

But what ails the euro, which has dropped about 20% against the dollar since its 1999 launch, is more fundamental than the pratfalls of ECB officials or even interest-rate policy. Simply put, investors just don't have much confidence that the companies and economies of the euro zone are the best places to put their money. And these days that is what makes a currency go up or down. Says the financier George Soros: "If you want a strong currency, you have to create conditions that will attract capital. That's the key to the weakness of the euro."

Despite all the marketing of a new, vibrant Europe, the Continent bled money last year. A net $56 billion left Europe for U.S. and Asian stock markets. Mergers and acquisitions were an even more important factor. A total of $147 billion departed Europe for other climes where corporate chieftains judged the opportunities superior. That was more than enough to overwhelm the euro zone's $43 billion current account surplus.

While it is still too early to obtain solid statistics, investment banks in London think that a similar pattern could be emerging this year. For instance, Cameron Crise, a currency strategist at Warburg Dillon Read in London, says that the bank's equity sales force, one of Europe's largest, reports that its clients are continuing to sell European equities to raise cash to buy in the U.S. and Asia.

A vicious circle is developing. The euro's weakness has hurt the image of the currency itself, making traders who have been repeatedly burned extra-skeptical. At the same time, portfolio managers are wary of investing in the euro zone, fearing that the value of their investments will be eroded by a declining currency. Many currency strategists in London are still betting that the euro will soon turn around. They argue that the currency has fallen so low that it is undervalued by most measures. In addition, they say that mainstream U.S. stocks are underperforming their French and German counterparts this year. And the euro zone is expected to show strong growth over the next few years--unless the ECB manages to choke it off with foolish rate hikes.

There are signs of building some strong European technology companies at a time when the shares of many U.S. corporations look tired. But U.S. high tech is still attracting cash from across the Atlantic and until Europe solves its structural problems and the CAC and the DAX beat the Nasdaq, restoring confidence in the euro may be difficult indeed.

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