Euroland Balance of Payments Suggests A Weaker Euro

July 24, 2008

The current account in Euroland was in deficit in three of the first five months of 2008, and the January-May combined current account was also in the red to the tune of a mild EUR 5.8 billion.  That amount was similar to the seasonally non-adjusted five-month sum of EUR 5.4 billion, representing an adverse swing of EUR 17.6 billion from a surplus of EUR 12.2 billion in Jan-May 2007.  Direct investment generated a net capital outflow of EUR 209.8 billion in the first five months of 2008, EUR 51.2 billion greater than a year earlier.  Portfolio investment inflows at the same time dropped from a EUR 366.3 billion to  EUR 168.1 billion, an on-year deterioration of EUR 198.2 billion.

When major currencies were fixed to the dollar prior to 1973, strain on international monetary system and relative support for different currencies could be gleaned by monitoring long-term capital flows and current account positions.  The so-called “basic balance” of Euroland (current account plus direct investment plus portfolio investment) swung from a surplus of EUR 219.9 billion in Jan-May 2007 to a deficit of EUR 47.1 billion in Jan-May 2008.  That was a deterioration of EUR 53.4 billion per month or $83.7 billion per month translated at the present euro/dollar exchange rate.  At the end of May, contrary to what the balance of payment was suggesting, the euro stood 6.5% above its end-2007 dollar value, and it has strengthened by another 1.0% since end-May.  Without short-term capital underpinning, the euro would probably be trading below current levels.  As explained in earlier postings, I am bearish on the dollar in the long run.  I expect the dollar to be weaker against the euro five years from now and weaker still in 2025.  However, a good case exists for expecting bouts of dollar strength within those long stretches of time, and an upward dollar correction seems way overdue after its prolonged and steep losses since 2006.  Euroland’s balance of payments data reveal the euro’s vulnerability.  The flow of Euroland economic news has also been lately deviating to the downside of expectations by a bigger margin than have U.S. economic trends.



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