This week it is more of the same: great news from the U.S. economy but a flagging stock market as Europe continues to struggle and the euro erodes.
Views on the Dollar Change on a Dime
Just a few months ago the popular press was filled with articles about how to hedge one’s exposure to the U.S. dollar. I have long believed that higher productivity, more favourable demographics, and greater labour flexibility would make for a stronger dollar in the years ahead. However, I had no idea that the cracks in the European system would be exposed this quickly and that the dollar would rebound this strongly.
European Leaders Fail to Find a Common Voice
The euro has now fallen from a high of EUR 1.6 per $1 to EUR 1.24 per $1–which is where it was way back in 2008. Despite excitement over the European bailout plan earlier in the week, enthusiasm quickly faded as individual countries fretted about implementing austerity plans and politicians began to more openly worry about the euro’s demise. There was even a rumour (later denied) that French president Sarkozy threatened to take France off the euro. It certainly didn’t help that the chief executive of Deutsche Bank (DB) publicly questioned Greece’s ability to repay its debts in a televised comment.
Eurozone politicians are in many ways sabotaging themselves with the lack of a common story line and a single voice–a benefit that was certainly instrumental in helping the Federal Reserve bring the U.S. out of its mess.
The Biggest Problem with a Weak Europe: the U.S. Banking System
An indirect risk to the U.S. economy from the European debacle is related to the various European banks that hold a lot of government (sovereign) debt. These banks do business with U.S. banks and are counterparties in many transactions. If banks start distrusting each other again, that could cause additional problems in the U.S. banking system. This time around, however, the U.S. banking system is better capitalised than before the subprime fiasco in this country.
European Exports Represent Just 2%-3% of U.S. GDP
The direct effects of a weaker Europe on the U.S. are less clear. Total U.S. exports account for only 12% of total U.S. gross domestic products, making us one of the most self-contained countries among developed nations (in contrast, Germany derives almost 40% of its GDP from exports).
Breaking that down even further, the eurozone constituted just 20% or so of U.S. exports in 2009. So even if U.S. sales to the eurozone immediately and permanently dropped to zero, the effect on the U.S. GDP would be just over 2%.
As bad as things may get, I don’t think we are going to reach zero sales to Europe anytime soon.
Europe Will Be More Competitive, Companies With Large European Exposures Will Be Hurt
Unfortunately, a softening euro will create other problems. A weaker euro will make some European products more competitive in other world markets, although sky-high productivity in the U.S. will erode some of that advantage. Individual companies with large European exposures, such as consumer goods companies, could also see their profits cut short as sales in euros translate back to fewer dollars of U.S. profits. The dollar tailwind of late 2009 is in the process of turning into a headwind.
For a bigger picture of the European crisis and the recent bailout, this article from the Wharton School of Business provides an interesting European perspective.