So what’s with the euro? The single currency declined from being worth a relatively robust (in historical terms) $0.96 at the turn of the year to just 88 cents at in April 2001. And that was despite a frightening global financial market that saw the Nasdaq Composite off by over 25 percent in the first quarter of 2001, and Japanese banks fighting for their lives. By comparison, European economies – and stock markets – have held up pretty well, so why should the euro be back on the slide this year?
The real oddity lies in the continuing strength of the dollar, rather than the weakness of the euro, which may help explain why Eurocrats and ministers appear so relatively relaxed in the face of their currency’s decline. After all, last August, when the euro dipped to below $0.90 after a year and a half of pretty steady decline, the Euro-powers-that-be were beside themselves with anxiety – as were other financial policy-makers. The result, a month or so later, was that the G7 industrialized nations intervened to try to stem the tide of anti-euro sentiment.
But this time they all seem happy to let nature – or at least the markets – take their course. That may be because the euro is now relatively stable against most foreign currencies – apart, of course, from the relentlessly (and inexplicably) ascendant greenback. Few can explain its appeal very convincingly; indeed, it can really only be justified in terms of the overall uncertainty of the global economic situation, which tends to steer punters back to the assumed safety of the dollar.
But whatever the reasons for and reactions to the euro’s decline, it has real implications for global companies doing business in Europe. They haven’t had much to cheer about since the euro was rolled out amidst great fanfare in January 1999. On that day the eurozone, with a population of 350 mn, became the world’s second largest economy after the US; and the Frankfurt-based European Central Bank (ECB) took control of monetary policy in all those countries participating in Europe’s Economic & Monetary Union (Emu). The ECB sets euro interest rates and is preparing to issue euro bank notes and coins next year.
So Emu effectively brought about economic convergence for most countries in the European Union (EU): Austria, Belgium, Finland, France, Germany, Luxembourg, Ireland, the Netherlands, Portugal and Spain. Greece joined later – at the start of 2001; the UK, Denmark and Sweden all chose not to join – or not yet, anyway.
Tough sledding
From the outset, it’s been a rocky road for the euro. In its first two years of existence, the new currency lost more than 30 percent of its value against the dollar. That’s bad news for US investor relations officers at companies active in the eurozone, since a weak euro affects reported profits and damages their sales in Europe.
For evidence, look no further than Intel’s announcement in September 2000 that its third-quarter sales had fallen short of forecasts due to weaker demand in Europe. That’s because the euro’s weakness makes prices of US goods, like Intel’s computer chips, more expensive in Europe and therefore less competitive. And that in turn is one of the reasons underlying Intel’s 22 percent stock price plummet.
Intel’s far from alone; many other companies doing business in Europe felt the pinch. Take Los Angeles-based Allergan. Its stock was decimated in late 2000 after an analyst downgraded it, raising concerns that Europe’s sagging currency was eroding the company’s sales.
While an Allergan spokeswoman emphasizes that the company’s fundamentals remained strong, she notes that the euro’s decline in 2000 was probably responsible for shaving about 2 percentage points off the company’s sales in the first six months of last year, or about $16 mn.
The pharmaceutical firm, which generates about 25 percent of its sales in Europe, represents just one example of the way the euro stifled the financial performance of US companies in 2000. Gillette, the leading maker of razors, said that the drop in the value of several currencies, particularly the euro, reduced the dollar value of its sales by 6 percent in the third quarter of 2000, compared with the previous year. The news sent its stock down $2.19, or 7.3 percent, to $27.62. And Bausch & Lomb warned investors in 2000 that the continued decline of the currency was one of several factors accounting for disappointing earnings and sales. McDonald’s and Estee Lauder also warned that the sluggish euro was eroding their European sales and earnings.
Structural change
So much for the perspective from across the Atlantic. Back on the European continent, the beauty of Emu for companies trading predominantly within the eurozone, of course, is that all twelve Emu countries now effectively trade amongst themselves in their domestic currency – the euro – to produce highly desirable stability. Still, stock prices are determined not just by trading performance but also by global demand. And there’s not been too much of that where euro-denominated stocks are concerned.
Indeed, investment funds departed the eurozone at a pretty fast pace in the first few months of 2001. The total portfolio outflow – bonds and shares – during January alone was e45.5 bn. That was the third highest monthly level since the euro’s launch and it was the equities portion that was most alarming.
According to Christopher Swann, currency correspondent at the Financial Times, ‘Foreign sales of European equities provide some evidence that US investors are now unloading shares in eurozone companies they received during the merger and acquisition boom of last year.’ And he notes that, in the meantime, European investors were going on investing heavily in the US market, notwithstanding the dubious climate there. One factor underlying this may be that pension funds in the eurozone now have the freedom to invest more widely, in geographical terms, than in pre-euro days. That’s because whereas in the past a 10 or 15 percent foreign allocation would have to be spread around the entire globe, including neighboring countries, the whole foreign allocation can now be invested outside the eurozone, since all countries in the eurozone are now classed as the domestic market for investment purposes.
Glimpsing the future
In short, then, things are still looking pretty glum both for international companies commercially active in the eurozone and for eurozone-based companies trying to maintain healthy share prices. So what can such companies expect in the months to come? What lies ahead for the euro?
Some forex players blame the euro’s weakness on the ECB’s reluctance to cut interest rates when that could be a crucial boost to eurozone growth. By the time of the Fed’s surprise mid-April cut, the ECB remained the only major central bank not to ease monetary policy in 2001.
Still, commentators like US stock speculator George Soros say that as the US economy heads towards an anticipated recession, the euro deserves a close look. And many others are still on the lookout for dollar weakness in the near future, as the economy continues to decline, the stock market stutters uncertainly at best, and the Fed continues to reduce interest rates.
That’s music to the ears of europhiles like Bank of France governor and Emu board member Jean-Claude Trichet, who has long advocated the merits of the euro. In January he stated, ‘It seems to me that we have all the means necessary to be able to resist an international environment that could be a little less favorable,’ referring to the slowdown in the US economy.
Proclaiming confidence that the US would be able to oversee a ‘gentle’ slowdown, Trichet said that Emu countries were now anyway in a better position to manage the impact of a weaker US economy, thanks to the euro. It should be possible to have robust, continuous growth, without inflation, which is therefore lasting, he stated.
That sentiment is echoed by Teun Draaisma, a strategist at Morgan Stanley Dean Witter, who anticipates the euro will reach parity with the dollar by the middle of the year. ‘This view is based on a closing down of the gross domestic product differential,’ he says, referring to similar projected rates of economic growth in the US and Europe, ‘and a marked deceleration of net flows into the US, related to tighter credit conditions and a reversal of sentiment on the technology sector and the euro.’
He may be onto something. According to a recent study by Merrill Lynch, the euro is now the favorite currency of 68 percent of global fund managers – a five-year high for the study and up from 64 percent a year ago. On the other hand, the art – or possibly the science – of foreign exchange rate prediction is a mug’s game. No-one can forecast future rates with any certainty. Indeed, the only certainty about future dollar/euro rates is probably that IROs will have to keep on explaining their impact on performance – come what may.
Some reporting by Brian O’Connell
