As I write, the euro stays deep in its despond at just $0.96/e. That’s a far cry from $1.15/e at its launch. Why does the euro stay weak?
There are two key reasons. First, investors still see the US economic cycle as much stronger than core Europe’s. Europe is still pottering along at around 2.5% a year while the US races by at over 4% annually. And the data for household spending continue to hit the highs in the US, while Germany struggles to register much more than 1% annual growth in shop sales.
America’s spending binge has provoked a more hawkish Federal Reserve with Alan Greenspan clearly in a tightening mode. As a result, interest rates in the eurozone are some 3% below those in the US and that’s hardly supportive of the euro.
But the main reason why the euro languishes and the greenback glows is that global investors continue to pump huge flows of capital into US financial assets, particularly into US corporate mergers and bonds. That keeps the greenback strong, despite the US running a current account deficit of over 4% of GDP. And many of these investors into the US are European. Last year, net outflows of direct investment and portfolio capital worth 6% of Europe’s GDP left its shores, mainly to cross the Atlantic. No wonder the dollar thrived against the euro.
It’s not difficult to see why that money went over the ocean. In the market’s eyes, Europe is not only lagging the US in economic growth, but also in its ability to take advantage of the cyber revolution. The new technology has raised US productivity significantly and it has brought dot com companies to the stock market, which has rocketed in value. The 300 top US internet-related companies now have an average market capitalization of $20 billion, 33 times larger than the average for the 5,100 Nasdaq companies as a whole.
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Take internet usage. The latest data show that there are 120 million Americans connected to the net, way more than the rest of Europe combined and six times more than the next largest connected country, which is Japan. The internet economy in the US is now generating $500 billion in revenues and employs 2.5 million people. It’s zoomed past-old industries such as airlines. Europe cannot compete with this investor value.
But what has kept the euro weak in the last 15 months will soon change. First, contrary to the skeptical perception of investors, Europe’s economic core is on the move. In particular, German consumers are beginning to spend.
Germany’s retail sales figures don’t show that. In fact the data consistently understate German consumption. They only record sales in city centres and fail to capture much of the fast-growing high-tech consumer goods sector, like computers and mobile phones, which are increasingly sold by mail order or directly by the phone companies.
Again, the data on the property industry suggest recession. But weak construction activity is almost totally concentrated in eastern Germany. In the west, building orders are moving up. And Germans are spending more on their holidays abroad, again something not captured by retail sales data.
Up to now, this increased spending has been financed by higher take-home pay for those in work. But now employment is starting to rise too and recent falls in unemployment in January and February of this year suggest that job creation will continue throughout 2000, despite accelerated restructuring and mergers among German corporations. That’s why consumer confidence surveys are recording all-time highs.
The other key change is the corporate culture in the heart of Europe. The Vodafone-Mannesmann merger is a landmark event in Germany. One of the jewels in the German corporate crown has been lifted by an Anglo-American raider and, after an initial protest, it’s been accepted as inevitable by the German government and organized labour. The merger displays all the features of the new economy: two technology-based companies merge across national barriers and implement corporate rationalization in order to maximize shareholder value.
And the more recent Deutsche-Dresdner bank merger is another. It marks the globalization of Germany’s financial system as Deutsche relieves itself of domestic retail banking, concentrates on global corporate banking and bases itself in London, not Frankfurt. What all this tells you is that Europe has put up a big neon sign and declared itself “open for global business!”
This alone will be enough for Europe to start attracting the capital that, up to now, has gone to America. But from here on out, Europe is going to catch up in the cyber revolution too. Growth in internet usage and e-commerce revenues will be much faster in core Europe than in today’s cyber leaders, the US and the UK. Surveys show that internet usage in the US will rise 20% a year up to 2002 and e-commerce revenues will rise 60% a year. But that’s nothing to growth in Europe. German internet usage will grow 50%-plus a year and France’s will double each year. And e-commerce will jump, admittedly from a very low level, by 150-200% a year in Europe.
The impact of this on Europe’s growth rate will be significant. Even without the new economy, on official measures, Europe will grow by 3.0-3.5% this year and the US by something similar. But Germany’s GDP measurements do not fully account for the cyber revolution. If Germany’s GDP price deflator assumed the same disinflationary effect of new technology on prices as does the US deflator, it would add 1% point to Germany’s real GDP growth. If adjusted for that, the real GDP growth differential with the US would be reversed in 2000! So get ready for the euro’s comeback.
David Roche is president of Independent Strategy, a research firm based in London. www.instrategy.com
