handful of American consumers–especially tourists visiting Europe–stand to benefit from the U.S. dollar’s recent strengthening against the euro, but the wider impact on the U.S. economy may not be as positive.
Over the past year and a half, the euro has fallen as the common currency for much of the European Union. One dollar now buys approximately one euro, after a 20 percent decline in European currency relative to the greenback over the last year. This is the first such purchase in nearly two decades.
The drop in the euro’s value results from recent global economic challenges–a war in Ukraine, supply-chain shocks, inflation and pandemic inspired stagnation, all of which are hitting Europe much harder than the U.S. However, America and the E.U. will feel the effects of this currency change. According to experts, it could be years.
Here’s what you need to know.
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Good News For American Tourists
The U.S. and Europe are major trading partners. This means that any changes in either economy can have an impact on the other. The dollar’s strength means imports from the eurozone will be cheaper for Americans, and those savings could add up to a significant amount. The U.S. imported goods and services from E.U. in 2019 was $598 billion According to U.S. government statistics, $598 billion was the total. Most of this came from more wealthy countries like France and Germany. Top imports included pharmaceuticals and machinery as well medical devices and food. Given American consumers’ propensity to spend, one might expect imports from Europe to surge. America’s consumers will feel some relief in their pocket books as well.
Additionally, weaker Europe might impact American exports which could in turn affect American jobs. These numbers again are huge. 468 billion dollars worth of services and goods were exported by the United States to the E.U. According to the Office of U.S. trade Representative, the U.S. exported $468 billion of goods and services to the E.U. in 2019. According to the Office of the U.S. Trade Representative, these big categories were energy, machines, and medical equipment. The U.S. might see layoffs within these industries or related sectors if exports drop.
Americans visiting Europe this summer—those who can get past the travel chaos—will get more for their money, which may benefit European stores, hotels, bars and restaurants. If you have a lot more to spend the euro might allow you to purchase a Tuscany vacation home. Travelers from Europe to the U.S. will, naturally, have lower spending power.
Wall Street has the opportunity to make some deals. “I am suggesting to U.S. private equity funds and corporations to look at Europe for assets, including real estate,” says Marc Chandler, chief market strategist at Bannockburn Global Forex. Simply put, Europe offers a great place to get more value for money.
There’s more good news: There is little chance of the weakness reversing anytime soon. Chandler sees little chance of the ECB intervening to halt the euro’s drop. “I think there are two chances: slim and none, and slim just left town,” he says.
Two Central Banks: A Story
The euro’s decline is partly down to the different approaches central banks on opposite sides of the Atlantic have taken, and how investors have responded. According to Steve Blitz (chief U.S. economist, macroeconomic research firm TS Lombard), investors can earn higher interest rates on risk-free U.S. dollars deposits than they do on euros-denominated depositors. Three-month Treasury Bills investors get an annualized interest of 2.3%. Blitz anticipates that it will soon jump to 4%. This is compared to the less than zero interest paid for equivalent investments in German euro-denominated savings. “You can make a lot more money with no risk by holding dollars,” he says.
Federal Reserve waged an aggressive war on inflation to reduce the rise in rates. The latest 9.1% was the reason for the higher U.S. rates. Although the Fed is often criticized for slowing down, they have moved much faster and more aggressively than their E.U. counterparts. The European Central Bank (ECB) is its counterpart.
Steve Clayton of Hargreaves Lansdown, U.K.’s head equity funds, said the Fed learnt its lesson during an era of persistent inflation in 1970s. “History tends to show that moving quickly and decisively on monetary matters is the best approach,” he says.
But the ECB wasn’t around in the ‘70s, and there has been no similar period of inflation since the euro was launched a little over two decades ago. In addition, the ECB is generally hesitant to make policy moves that might weaken Europe’s financial sector, Clayton says. That’s why its efforts to raise rates massively lag the Fed’s despite European inflation rates being similar to the U.S. rate.
In any event, a European recession could solve the ECB’s inflation problem, as a shrinking economy also tends to reduce inflation. And some experts see that coming soon because Europe’s economy is far weaker than the U.S. Europe’s been hit much harder with the energy crisis following Russia’s invasion of Ukraine in late February. “We’ve been forecasting a recession in Europe since March,” says Robin Brooks, chief economist at the Institute of International Finance. At least part of the issue is that Germany, the powerhouse behind the E.U.’s economic system, has had its own economy upended.
Brooks says that Germany’s dependence on Russia for cheap energy and materials to produce manufactured goods has been strong for decades. Brooks states this. “That business model is really challenged now,” he says. The key cost input for electricity generation in Europe, natural gas from the EU, has been 10x more expensive than in the U.S. In recent years, Germany remains heavily dependent on Russia to import crude oil.
Also, the falling euro might increase inflation already at an all-time high in eurozone. European businesses will find it more costly to purchase raw materials that are needed for production of goods. Many commodities can be priced in dollars. This will most likely result in higher prices for consumers.
While inflation at more than 9% worries most central bankers, Brooks doesn’t see the ECB raising rates aggressively raising the cost of borrowing money if the economy weakens much more. “If there is a recession, there’s no way the ECB is going to hike rates,” he says.
Brooks predicts that the result will see the euro remain at parity or lower with the dollar. “My bias is that we are headed for a multiyear period of year sub-parity,” he says.