Schröder Is Right on the Mark!

How can politicians rejoice in the weak euro?

September 8, 2000

How can politicians rejoice in the weak euro?

With the euro bouncing around record lows, why are so many European economists frowning? While many Europeans view the euro’s weakness as a problem, they ought to see it as the opportunity that it is. Europe needs all the help it can get in its effort to restructure its industries. The U.S. example of the 1980s shows how a weak currency, by making U.S. goods less expensive for foreigners and thereby boosting demand for U.S. exports, can help overcome some of the difficulties in revitalizing an economy.

To many Europeans, the euro evidently represents something besides just a currency. Some European economists apparently view it as a sign of strength, an instrument of power — the means by which Europe wrenches its share of world leadership from the United States. To these Europeans, the euro’s fall suggests failure.

Actually, the euro’s weakness represents a success of sorts. Any economy undergoing significant restructuring — which inevitably weakens the domestic economy in the short run — benefits from a weak currency, as the latter tends to strengthen foreign demand.

Even though the intra-European restructuring process — involving the consolidation and modernization of industries — spans across many national economies, the euro has allowed the process to occur without any economic shocks. Imagine all the hoopla and backbiting had a whole range of European currencies plunged to uneven levels.

Europe undoubtedly faces a tough task in the next few years. As the European Union heads of state reiterated at their summit in Lisbon last month, the main focus of European policy is to accelerate the restructuring of European businesses so that they can become more competitive. Fortunately, the Europeans have a roadmap for this process.

About 15 years ago, U.S. companies began a similar restructuring. By the late 1980s, they had a powerful ally in their drive to become more competitive — the dollar. Beginning with the 1985 Plaza accord, and through the end of 1987, the dollar fell by about half, to 1.57 German marks from 3.30 marks, and to 121 Japanese yen, from about 260. The dollar’s decline helped keep the U.S. economy growing.

General Electric CEO Jack Welch leaves no doubt just how important the dollar’s depreciation was in aiding the transition of U.S. industry to more efficient management and better use of technology. “We’re pounding ourselves on the chest in America over how wonderfully we’ve done,” he said in a 1998 interview in the Financial Times. “Yes, we did restructure, but we got a huge help from the currency.”

Why, then, would many European economists and decision-makers want to try to accomplish a similar restructuring but with a strong currency? It seems almost suicidal. If the mighty United States needed the aid of a weak currency to restructure its economy, why not Europe?

Foreign-exchange markets have confirmed continued euro weakness for some time. Calculations by the U.S. General Accounting Office based on pre-1999 currency prices show that, had the euro existed in early-1996, it would have been worth more than $1.30. The currency’s drop in value over the past four years is just roughly half the dollar’s depreciation between 1985 and 1989. The euro could go as low as 65 cents, if it continues to follow the dollar’s path.

Perhaps the currency markets have a deeper appreciation for the needs of the European economies than the worried pundits. Still, Europeans have fought long and hard against allowing currency depreciation for the purpose of boosting demand. Particularly in Germany, the traditional argument against depreciation has been based on concern about inflation. A strong currency, Bundesbankers reasoned, prevents imported inflation. In today’s low-inflation (some would say deflationary) environment, such concerns are overblown.

By the same token, those who have long argued that a weak currency could be abused by over-reliance on it — instead of making the necessary changes within corporations to better compete — no longer apply. The restructuring horse is out of the European barn, and won’t be put back. Global capital markets are forcing European companies to become more efficient — or risk being crushed by the competition.

The potential for helping short-run economic growth shouldn’t be underestimated. Considering that exports accounted for about 13% of euro zone gross domestic product in 1997, a 5% increase in exports — a reasonable assumption given even a modest euro depreciation — would boost euro zone GDP by 0.6 percentage points, a substantial amount.

Headline mergers such as Vodafone AirTouch Plc’s takeover of Mannesmann AG — and the less obvious changes in financial and managerial behavior — are bringing corporate Europe into a new era. As restructuring progresses, Europe needs to keep the potential damage, such as firings and relocations, to a minimum — at least until the benefits of restructuring become obvious to all. Once that happens, the euro will rise.

Until then, nobody should lose any sleep over the currency’s decline.