Europe hit by fall of US dollar

The euro's surge this week makes exports more expensive and businesses nervous.

When Europe's common currency, the euro, reached one-to-one parity with the US dollar this week for the first time in over two years, one might have expected some proud chest thumping on this side of the Atlantic.

In fact, the few cheers that went up were distinctly muted.

The rapidly sliding dollar poses as many problems for Europe as it does for the United States, economists say.

Among the concerns:

• A weak dollar means a strong euro, and that hurts European exports. French cheese and Scandinavian furniture, not to mention steel and automobiles, are now more expensive abroad. Every 10 percent appreciation of the euro knocks a percentage point off the European Union's GDP, say economists at the German bank Dresdner Kleinwort Wasserstein.

• Central European currencies and stock markets are rising quickly – too quickly. That's destabilizing for developing economies.

"The sharp jump in the value of the [Czech] koruna was caused by speculative capital," says Marketa Sichtarova, chief economist at Volksbank CZ. "These are short-term investments .... They are not real businesses," and carry with them the risk of future collapse.

The psychological boost of equality with the world's preeminent currency will soon wear off, they forecast, as the implications sink in.

"The story is dollar-negative, but it is not euro-positive," warns Mikael Schubert, an economic analyst at Commerzbank in Frankfurt.

The heart of the problem is that a higher euro will make exports from the 15- member European Union less competitive on international markets. And for the last three years, it has been exports that have largely driven economic growth in the EU.

The picture is even bleaker in central European countries, whose emerging economies are dangerously export-dependent. The rise of local currencies there against the dollar threatens thousands of bankruptcies and tens of thousands of layoffs, just as the former Soviet bloc nations are finding their economic feet.

European economists have long argued that the dollar was riding artificially high in world currency markets, while the euro slid from its launch rate of $1.17 to a low of 86 cents. That happened, they say, because of the massive migration of international funds to the United States, sucked in by the exuberance of high growth rates and a booming stock market.

That flow masked a structural problem with the US economy – a current account deficit that is due to reach $450 billion this year, requiring $1.7 billion of capital flows each working day to cover it. As this money dries up, the deficit is being revealed, pushing the dollar down.

It is drying up because international investors, frightened by the recent string of accounting scandals in the US, are wondering whether American businesses are really as strong as they appeared. The plunging US stock market no longer looks like a safe place to put money.

And as investors flee dollar-denominated assets, they are turning not only to traditional havens, such as the financial markets in London or Frankfurt, but also to lesser known opportunities, such as the Czech Republic, where the stock market has been performing well.

That has driven up the value of the Czech currency, the koruna, by 25 percent against the dollar during the past year, most of it over the past four months. And that is bad news for a country that depends on exports for 71 percent of its GDP.

Take Ivan Galan, for example. Ten years ago he rode a wave of entrepreneurial optimism that swept Eastern Europe after the fall of communism. As a young businessman he made all the right moves and was rewarded by solid profits from his exports of metallurgical supplies and machinery to Scandinavia. Today, his 25 percent profit margin has been wiped out by the koruna's rise.

"My export business is finished," he says in an elegant office in Prague that he can no longer afford. "My customers cannot tolerate a 20 percent price rise in one year, and I cannot absorb the cost in the long term. I will make nothing this year, if I am lucky."

Though exporters are the first to be hit by a rising currency, other firms will suffer too, says David Marek, chief economist for Patria Online, an economic consultancy group in Prague. "The change in rates is happening too fast," he worries. "The real economy cannot adapt, and soon it will hurt not only exporters but also companies that manufacture for the domestic market, because they will find it more difficult to compete with foreign products."

Even more worrying for a young and fragile market economy such as the Czech Republic is that much of the investment flooding into the country is not investment in new factories and jobs, but short term money hoping to make a profit from the stock market and the exchange rate.

The situation is not so grave in Western Europe, where exports beyond the euro zone account for only 12 percent of GDP. But the likely fall in those exports will hit the EU's growth prospects, which the European Central Bank estimates at only 2.25 percent a year over the long term.

Economic recovery in the EU was already looking shaky, and European stock markets are falling in line with the Dow. Frankfurt's DAX, for example, is down by 20 percent.

With domestic consumption lagging, and in no shape to pick up the slack from falling exports, the prospects for European growth do not appear to justify the euro's rise. But it looks as though it will continue.

"The most important factor is the turnaround in sentiment," says Mr. Schubert.

"The clear positive sentiment in favor of the dollar over the past three years caused a very serious misalignment" in its value against the euro, he adds. "Now the crisis surrounding accounting practices in the US and low equity prices have triggered the whole process in reverse."

That may bode ill for Europe's economic fortunes in the longer run, but for the time being, the cloud has a silver lining.

"Psychologically, the euro's parity with the dollar is very important for Europeans," says Jerome Sheridan, who teaches economics at American University's Brussels outpost. "The public has seen the decline in the euro's value as meaning the currency was a mistake. Parity will make Europeans feel better about themselves."

• Arie Farnam in Prague contributed to this story.

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