Anxiety Over The Euro's Strength

October 27, 2009

An editorial in the Tuesday Financial Times pushes the view that worries about euro appreciation are “overdone” and makes several credible points.  Consumers benefit from cheaper import prices.  Much of the region’s external trade is with one another, where exchange rate exposure has been eliminated by the common currency.  It’s not such a bad thing either that euro appreciation trims the bloc’s collective trade balance, because such facilitates the needed reduction of U.S. and British deficits.  Other points could have been added.  A strengthening currency gives the ECB greater latitude to keep interest rates low without jeopardizing price stability, and the discipline of a pricey currency encourages businesses to take other steps to retain a competitive edge.

Europe, after all, has been coping on and off for decades with a slip-sliding dollar.  Is the present bout of euro strength any more challenging than what’s been faced before?  It seems to be so in one respect, and that is the duration of the euro’s climb without substantial interruption.  The table below shows a sequence of five-year averages for the mark against the dollar during the 25 years prior to the euro’s launch.  Before 1999, the D-mark was the regional lynchpin, and the Bundesbank set monetary policy for the area much as the ECB has done subsequently.  The table also indicates the per annum rate of change in the five-year mark averages against the dollar.  The long-term trend of the mark was upward, but the pattern was saw-toothed with plenty of back-hoeing and filling that gave exporters ample space to adjust to the mark’s higher settings. Mark gains against the dollar were often mitigated by erosion against the yen.  The 3.7% annualized increase in 1974-78 is from 1973, the first year of flexible, market-determined dollar exchange rates.

  DEM/USD Change Vs USD
1974-78 2.3762 +3.7% per annum
1979-83 2.1784 +1.8%
1984-88 2.2834 -0.9%
1989-93 1.6750 +6.4%
1994-98 1.6113 +0.8%


A similar table below looks at the euro era in the same way.  The 4.0% per annum decline indicated in the first five years (1999 through 2003) is measured against the euro-translation value of the mark in 1994-98.  This was followed by five years in which the euro recorded an average value that was 32.7% (or 5.8% per annum) stronger than in 1999-03 on average.  The euro at the same time advanced 4.8% per annum against the yen, a faster rate of climb against Japan’s currency than clocked in any of the pre-1999 periods shown in the first time.  Based on the give-and-take pattern of the D-mark era, some projection shops had assumed that the dollar would now experience a multi-year period of appreciation in reaction to and following its sharp drop earlier this decade, and the stronger dollar late last year and in 1Q09 was mistaken for the beginning of a multi-year trend reversal rather than an artificial and comparatively short-lived respite based on safe-haven flows into U.S. Treasuries.  The last row compares today’s closing against the euro’s year-to-date average.

  EUR/USD Euro’s Change
1999-03 0.9922 -4.0% per annum
2004-08 1.3171 +5.8%
2009 Year-to-Date 1.4204 +1.5%
October 27, 2009 1.4794 +4.2%


A simpler way to convey the above message is to realize that yesterday was the ninth anniversary of the euro’s all-time and cyclical low of $0.8228.  At $1.4794, the euro is 80% stronger than then.  It is currently still trending higher, not lower, and its July 2008 record peak beckons just 8.4% above the present level.  The time and distance combination of nine years and 80% presents an extremely big shift in EUR/USD even by historic standards especially in light of the solidly upward  momentum since last spring.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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