Strong dollar Green Is Back

The euro is weakening, the dollar is rising. It's only a question of time before the two currencies reach parity. This development is like a new drug for investors and the economy in some countries – with unknown consequences.
Experts expect one euro can soon again be bought for one dollar.

It feels like déjà-vu all over again.

In the United States during the 1980s, the dollar was so strong that businesses demanded protectionist measures from the U.S. government to weaken the currency. The backlash forced their hand: In 1985 there was a concerted action to weaken the "greenback." Central banks from around the world flooded the market with dollar reserves to try to push down its value.

Thirty years later, the strong dollar is again becoming a cause for concern.

Since the beginning of the financial crisis in 2008, the Federal Reserve in the United States has lowered interest rates to near zero levels. Companies have become used to the cheap money. Now that these good times may be over, the market is nervously reacting to any sign that indicates when the Fed plans to raise interest rates again. Just the expectation is making the dollar stronger than ever.

Today, the dollar is 8 percent stronger than the currencies of its main trading partners compared to one year ago. Against the euro, the 19-nation currency bloc that stretches from Ireland to Latvia, the dollar has gained 20 percent. While you had to pay $1.36 for a euro one year ago, today a euro costs just $1.08. Earlier in March it had briefly fallen below $1.05.

We are at the beginning of a global currency war. Stefan Kooths, Head of economic research at Kiel's Institute for World Economy

“By the end of this year at the latest, we will see parity between the dollar and the euro,” predicted Ulrich Kater, chief economist at Germany's DekaBank.

He's not the only one predicting such a fall. By the end of 2017, experts from Goldman Sachs expect the euro to drop as far as $0.80, which would mark a record in the currency's 16-year history.

While the Fed's moves are expected to strengthen the value of the U.S. currency, other countries are doing the exact opposite.

Since December last year, more than 20 central banks, including those of China, India, Australia and Canada, have eased their monetary policies in an effort to devalue their own currencies and to boost inflation.

The same counts for the European Central Bank, which has begun buying bonds and flooding the market with cheap money, sending the euro into its recent tailspin.

The Swedish central bank is also among the strongest supporters of easy money. The exchange rate between the dollar and Krona fell to its lowest level in six years after the Swedish bank pushed rates further into negative territory last month. Even the strong Swiss Franc, which has surged in value against the euro this year, has lost almost 15 percent of its value against the dollar in the last 12 months.

“We are at the beginning of a global currency war,” said Stefan Kooths, head of economic research at the Kiel-based Institute for World Economy.

The question is, how much longer will the Fed tolerate a rising dollar?

One year ago, nobody expected the dollar to become this strong. It was understood that the Fed would stop buying government bonds – its own form of quantitative easing – at some point in the autumn of last year.

The difference was that nobody was expecting the Frankfurt-based European Central Bank to start quantitative easing at their end.

ECB President Mario Draghi in January announced a plan to buy bonds worth €60 billion per month starting in March, a move that accelerated the strengthening of the dollar against the euro. Mr. Draghi said he wants to inject €1.14 trillion into European markets until September 2016 with the aim of raising inflation in the euro zone – currently still in negative territory at minus 0.1 percent – to closer to 2 percent in the coming years.


The market is nervously reacting to any sign that indicates Janet Yellen plans will announce a raise in interest rates


The downside is that the ECB's latest action is pushing down returns for European government bonds. As a result, investors are increasingly looking to the United States for investment opportunities.

The economic outlook is also playing in the United States' favor. In 2014, the U.S. economy grew by 2.4 percent – three times as strong as the euro-zone's growth rate of 0.9 percent. Most experts predict the U.S. economy will grow by 3 percent this year and in 2016, while Europe’s GDP may only expand by half that amount.

The reason for the strong U.S. economic advantage is that people have paid off most of their debt. Outstanding debt of households is currently at 107 percent of disposable income in the United States, compared to 135 percent in 2007.

In the euro zone, households have only just started to reduce their debt loads. Private debt still amounts to 162 percent of GDP – 30 percentage points more than at the beginning of the currency union.

“Debt reduction is giving U.S. citizens more leeway to spend,” said Harm Bandholz, the U.S. chief economist at UniCredit in New York. In addition, the stock market boom and net assets held by households have increased. Consumer spending is the most important driving force in the U.S. economy at the moment.

According to Mr. Bandholz, the U.S. Fed is going to increase interest rates before the end of this year.

The ECB by contrast hopes its easy-money policies will encourage inflation in the euro zone, which in turn could help consumers inflate away at least some of their outstanding debts.

“There is no end in sight,” said Ralph Solveen, economist at Commerzbank, about the ECB’s loose monetary policy.

Higher U.S. interest rates could make the dollar even more expensive and stall U.S. exports. Even though exports contribute only 14 percent of U.S. economic output, a strong dollar is harmful to U.S. firms. In the fourth quarter of 2014, overall revenue fell by $19 billion – more than double the loss during the previous three quarters put together.

If the dollar remains strong or gets even stronger, businesses may turn to the government – just like in the 1980s – to weaken the currency and protect them against foreign competitors. That could be especially damaging to current talks over a U.S.-E.U. free-trade deal called the Transatlantic Trade and Investment Partnership, which among other things is supposed to strengthen the prospects of medium-sized German firms hoping to access the U.S. market.

Within the euro zone the exchange rate has an asymmetric effect. Ulrich Kater, Chief economist at DekaBank

How does a strong dollar and weak euro affect the economy in Germany, Europe and the rest of the world?

For Germany, which has an export ratio of more than 50 percent, the current exchange rate is of advantage at first glance. After all, every fourth job in Germany depends in one way or the other on the export industry.

A rule of thumb of economists has been that if the euro falls by 10 percent compared to its most important trading partners, Germany's GDP will go up by 0.4 percentage points. According to the German Statistical Office, 26 percent of German exports are transacted in dollars. The United States is Germany’s largest trading partner outside Europe.

On the other hand, Germany doesn't really need a boost in exports. People tend to "buy German" because of the high quality of the goods that firms deliver, not because the price is low.

Another danger is that, if exports grow even further, it will widen the country's account surplus, which in turn will ring alarm bells in Brussels. The European Commission is already keeping a close eye on the 19 countries in the euro – not just to maintain a balanced budget, but also a balanced economy.

In November, the Commission singled out 16 euro countries for different types of economic imbalances, including Germany. In 2014, the country's trade surplus was at 7.7 percent of GDP, compared to 6.7 percent a year before. Berlin is already being asked to come forward with solutions to tackle this surplus, which critics say is just as dangerous to the European economy as a country running a significant trade deficit.

The weak euro can have varying impacts on the different countries in the euro zone, depending on just how much they rely on exports.

“Within the euro zone, the exchange rate has an asymmetric effect,” said Mr. Kater, the economist at DekaBank.

While Italy, France and Spain can benefit from a weak euro, for example, Greece will not. The latter doesn't rely heavily on exports, except for food.

“The exchange rate is not a way to solve Greece's problems,” Mr. Kater said.

The other concern stemming from a weak euro is that it could weaken a government's, or company's, fiscal discipline.

A weak euro is like a subsidy on exports. As a result, governments tend to be more lax on reforms and businesses with cost-efficiency measures within their company. This could lead to a reduction in competitiveness and increase pressure on the European Central Bank to devalue the euro even further.

"A policy of devaluing of the currency, which has as its goal nothing but the destruction of the value of the currency, is going to make an economy poorer, not wealthier," said Thorsten Polleit, chief economist at Degussa bank in Frankfurt.

The other downside of course is that European customers now pay more for certain goods from the United States. Apple’s Apple watch is 20 percent more expensive, given the current exchange rate.

Another problem is that almost all raw materials worldwide are traded in dollars, and therefore more expensive for European firms. Experts forecast that the textile industry will have to increase prices for next winter at the latest, because cotton prices have effectively risen by 15 percent since the beginning of this year. Corn, coffee, rice and sugar are also affected. Car drivers could also see the price of petrol go up, despite the falling global oil price.

Any European tourists to the United States should expect to pay almost 30 percent more now. That will hurt Germany, where about 21 percent of those who travel to foreign destinations visit the U.S. annually.

The strong dollar is putting pressure on emerging countries as well. Many governments and companies have taken on debt in dollars. Interest and repayments have increased as a result, which can lower the respective credit rating and investment opportunities. In the medium and long run, this may also have an effect on Germany and European importers.

“The increase of the dollar could have a great influence on the global economy, if it persists,” a statement of the Bank for International Settlements, or BIS, an international association for the world's central banks in Basel, Switzerland, said.

Businesses in emerging countries have issued bonds worth $554 billion between 2009 and 2013, according to the BIS. In Brazil, companies have about $450 billion in total bonds on their books. The dollar percentage of the entire global debt load is 63 percent.

“A rising dollar is strengthening that trend,” Mr. Kater said. “Emerging countries are being split into good countries and bad countries – depending on the reforms they have been implementing.”

Among the good countries are many Asian nations, who are well prepared to withstand the economic uncertainty. Brazil on the other hand will run into bigger problems if the dollar continues to strengthen.

But what happens if the Fed decides to try to weaken the dollar as well?

Some people think this would be the beginning of a currency war like the one that took place during the 1930s. At the time, all countries sought to devalue their currencies to boost exports and create jobs at the expense of other countries. The result was a global round of protectionism.


This story first appeared in WirtschaftsWoche. To contact the authors: [email protected], [email protected] and [email protected] and [email protected]