April 12, 2011

Germany's biggest enemy: a strong euro.

Neither the (now certified) fall of Portugal nor increased debt pressures on other european peripheric countries have been enough to tumble down the never-ending rise of the euro exchange rate against other significant currencies. This should be very worrying for the heart and engine of the eurozone, Germany. I am sure Germany is already worried about that, what I mean is they should be worried enough to do something about it. 

A net exporter like Germany should not allow its currency to be its Achilles heel. Ok, the currency is not really German, but they are its founding fathers and the main reason why it exists... With this in mind, it becomes very difficult to understand why they allow 'their idea' to make their international trades more expensive and complicated. In the actual economic situation, competitiveness and efficiency are key to keep selling and Germany can lose their edge because of this. It is survival of the fittest.
The competitiveness indicators based on consumer prices published by the ECB show this trend clearly, see charts below (where 100% equals the index value in 1999 ) with an obviously sharp decline coincidental with the rise of the euro.
Harmonised competitiveness indicator for Germany. Credit: Deutsche Bundesbank

A strong euro is obviously good for debt issuing, for general borrowing and for imports but it can really hurt the muscle of Europe. Maybe you could think of it as eating everyday at McDonalds (no bashing here, just an example): it is cheap, it is easy and convenient as you can find one almost everywhere and it gets you through the day. But in the long-term fats are bad for your figure and, more importantly, bad for your most important muscle, the heart. The European Central Bank (ECB) is damaging the heart of Europe.
Problem is the people moving the threads of the euro, at the ECB, have their full attention on a totally different matter, inflation. They are quite right to be worried about long-term inflation, but as it always happens in economics, you must find a balance, a compromise between two opposite directions. In this case those directions are 'fighting inflation' on one side and 'keeping the eurozone competitive' in the other.
The ECB is mainly using the strength of the euro to contain inflation, while some economists are arguing that it is not core inflation what Europe is suffering, but 100% commodities-based inflation. In my opinion they are right  in saying commodities have a strong role in the late general rise in prices, but they should also see that core inflation is being engineered to look lower than it really is. Anyway, even if the actual inflation was really only commodity-based it has the potential to be highly detrimental to the European recovery in the long-term, so I personally think the ECB is right to fight it now before it is too late to avoid it. But they should only use one weapon to do this: interest rate.

Competitive depreciation of a currency is not highly regarded in economic circles, but when everybody else is doing it, Europe can not keep going in the opposite direction by maintaining such a strong euro. It has to adapt, it has to carefully look after its biggest member needs, and with Germany highly diversified customer base that means keeping a reasonable exchange rate for the euro against (mainly) the US Dollar, the Japanese Yen and the Chinese Yuan Renminbi.

If the trend of the euro does not change Germany will keep having its biggest enemy right at home.

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