Could the rising US dollar solve Europe’s Economic Woes? | THE POLITICUS

Could the rising US dollar solve Europe’s Economic Woes?

Weak GDP growth forecasts, recently released by the IMF, suggest a significant probability that one or more Eurozone countries could slip back into recession in 2015. The IMF predicted that the combined Eurozone GDP growth will come in at a meager 0.8% in 2014 and 1.3% in 2015; compared with 2.2% and 3.1% for the US. Stimulus measures undertaken, so far, by the European Central Bank (ECB) have not worked. The recent rise in the dollar exchange signals hope for Germany, regarded as the economic engine for Europe. Historically, Germany's economy has led the rest of Europe.

The Euro / US Dollar exchange has fallen to $1.26, and if the ECB pursues Quantitative Easing (QE) similar to the US Fed’s, the Euro could fall to $1.15 according to Allan Sinai, Chief Economist with Decision Economics. A Further rise in the value of the dollar would help all European economies and would particularly be a boon to Germany because its economy is export focused. The flip side of the coin is that US exporters will likely suffer. A drop in the value of the Euro from $1.35, where it had mostly hovered for the last couple of years, to $1.15 means a potential margin squeeze of nearly 15% for US exporters. Goods and services priced in US dollar will become 15% more expensive vs. European competitors’. This is big for large US exporters such as Boeing where the competition with Airbus for new orders is high. For US companies with international operations the problem does not end there. With a stronger dollar, foreign currency revenues will translate into fewer dollars on income statements, and unless replaces with domestic earned revenues, will also negatively impacting bottom lines. Usually, large US companies with significant foreign operations enter into currency hedging contracts with their banks to mitigate these swings in currencies, but none enters into contracts to hedge 100% of the risk as this theoretically is the antithesis of being hedged. Middle Market and small US companies may not have sophisticated Treasuries or bankers to deal with all this - some will find international sales particularly challenging in 2015 and possible beyond.

On the other hand, the rising dollar will favor US importers and manufactures that use imported components in their final products. What Europe is hoping will happen, is that the US will import more of their production of finished and semi-finished goods thereby creating jobs and putting back on track their economies.

To get its economies back on track, Europe will need more than a cheaper currency. Most recently, the Head of the IMF, Christine Lagarde, has been dropping suggestions everywhere that European governments need to add fiscal stimulus to the monetary stimulus already in place. This can come in the form of public investment in infrastructure projects, and tax reforms which will put more Euros in people’s pockets and create more spending and investment. In fact, Lagarde would like to also see the US undertake similar measures just to ensure that the economies across the pond are growing simultaneously. But with US public debt nearing $18 Trillion, and the election cycle underway, her call is unlikely to get any traction.

The world’s economies have limped along since the 2009 financial crisis. Although the US appears to be pulling ahead, Europe remains at risk. A cheap Euro is only part of the answer. The fiscal reforms being recommended by Lagarde are essential for Europe and governments there should heed her.