(c) 2013, The Washington Post.
(c) 2013, The Washington Post.
Planning a trip to Paris or Rome? It will cost you more than you expected. The euro is on a tear. Last week it was up almost 5 percent against the dollar since early September and up 8 percent since July.
The reasons are straightforward enough. Europe's long, deep recession appears to have finally ended, with growth in the second quarter of 0.3 percent (using the American practice of annualizing GDP numbers, that is the equivalent of a bit better than 1.2 percent growth). What had seemed as recently as the summer of 2012 to be an existential threat to the existence of Europe's common currency has abated. Meanwhile, it's looking like the U.S. Federal Reserve's easy-money policies will be in place a good bit longer than anticipated in early September, making the euro look comparatively more attractive. The runup reversed only slightly late last week, aftersome shakier Eurozone economic data came out.
So the underlying causes of the move are good for Europe. The continent was in a very dark economic place 16 months ago, and the fact that it may be turning the corner is something to celebrate. It's only natural that currency markets would adjust to reflect the return of (a little) optimism.
But there should be no champagne-popping at Europe's finance ministries or at its central bank in Frankfurt: This rally has been sharp enough that it could endanger the very economic growth they've been so desperately waiting for.
The math is simple. The rise in the euro against the dollar since the summer makes German or French exporters 8 percent less competitive than they had been against U.S.-based competitors. They are already groaning under tougher competition from Japan; aggressive stimulus by the new government there late last year has driven a 35 percent rise in the euro against the yen.
Those are pretty huge currency adjustments , and they risk undermining the fragile growth that the continent has finally achieved.
Perhaps more worrisome, the stronger euro will depress inflation at a time that a little more inflation is exactly what Europe needs to ease some of the pain of its readjustment. A grinding, unpleasant process is underway in which southern European countries such as Spain and Italy need to see wages fall relative to northern European countries. If they used separate currencies, this would happen almost automatically, through currency fluctuations. But because they all use the euro, the name of the game is "internal devaluation," with an adjustment that needs to happen through some mix of, for example, Spanish wages falling and German wages rising.
A couple of years of 4 percent or 5 percent inflation would help that process along a great deal. Essentially, it would allow Spanish wages to stay the same in nominal terms while declining in real terms. It is a much more painful adjustment when inflation is lower. In a world of zero inflation, more of the burden of adjustment must come through outright wage cuts in southern Europe.
Germany and the European Central Bank would never tolerate that 4 percent to 5 percent inflation, but at the least you might hope that the ECB hit its 2 percent inflation target. The stronger euro works against that, however, making imported goods less expensive, which is a force for disinflation.
Already, inflation is at a four-year low in the euro zone, coming in at only 0.7 percent in October. So the ECB is undershooting its inflation goal at a time that, if anything, overshooting that goal would help Europe sort out its mess.
The ECB could emulate the Federal Reserve by more aggressively creating euros to try to push inflation up toward 2 percent. The Fed has done that in the United States, buying Treasury bonds and mortgage-backed securities using newly created money. The ECB will be reluctant to buy government bonds out of a long, deep-seated principle to avoid central bank financing of member governments (a policy on which the bank has relented only at times of crisis, when the currency zone seems at risk of unraveling, not for run-of-the-mill monetary policy).
European political and economic unity has survived a profound threat over the last three years and proven more resilient than many American and British analysts thought possible. But now that very success is causing a new threat.
A stronger euro: Bad for American tourists. Bad for Europeans. Good for, well, the fact that it symbolizes a continent finally starting to see some light after five dark years.
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Irwin writes the Econ Agenda column for The Washington Post and is the economics editor of Wonkblog, The Post's site for policy news and analysis.