With the lack of insight that bureaucratic inertia brings, a celebratory mood is settling over Europe. There is great anticipation of the physical arrival of the euro after three decades of planning and three years of existence as a "virtual" currency. After all, it will affect over 300 million people.
Regardless of the hype, the euro has been far from an economic success and its political record has been mixed. Having lost about one-fifth of its value against the dollar since its introduction in 1999, it has also failed to insulate Europe from outside economic shocks. And it remains a political pariah in Denmark, Sweden and the United Kingdom.
The bad news is likely to continue. Look for continued weakness in the exchange value of the euro against the dollar. This weakness will continue as long as fewer global investors wish to hold the currency unit than wish to hold or borrow dollars. Despite large inflows of capital to the EU countries, capital outflows tend to be larger.
The causes of the weakness of the euro are many. There are macroeconomic misalignments of the European economies and a misalignment of internal policies of individual members. Added to all this is bureaucratic overreach by EU officials. Perhaps the most pressing cause for an expected fall of the euro relative to the dollar is that growth and productivity gains in the US economy will be higher than in Europe. This has caused a loss of confidence in Europe's economic momentum.
Germany, the region's largest economy, registered no growth in the second quarter, with Italy's economy suffering a similar fate. Unemployment in Germany recorded its biggest rise in nearly three years in October and business confidence posted the biggest drop in almost three decades. French jobless rates have rose for a fifth-straight month in September.
In all events, capital formation through fixed-asset investment by the private sector is widely considered to be the basis of sustainable economic growth. US companies are better able to exploit new technology than European firms because of a more flexible labor market whereby companies can readily introduce productivity-enhancing techniques. All of this helps explain both the strength of the dollar against the euro and the appeal of US equity markets to foreign investors.
This has led to considerably higher gains in productivity in the US than in Europe for the past few years. These gains reflect fundamental changes in the US economy due to reductions in transaction costs and a change in the burden of taxes initiated under the Reagan administration. More recently, the American economy has benefited from a wider application of technological improvements, especially in information technology, than in most other industrialized countries.
Unfortunately, the policies of many European governments have created a host of structural rigidities and barriers that inhibit the sort of risk-taking inherent with private investments. In sum, these policies increase what economists identify as "transaction costs" that are associated with economic exchange, including investments. Raising transaction costs tends to reduce exchanges and usually hampers growth.
As if to add additional injury to their rigid labor markets, EU member countries will impose restrictions on lay-offs. Employers will be required to consult with employees when redundancies are planned and workers will be able to demand confidential company information. This is supposed to allow workers to assess the situation and propose alternatives to layoffs or closures.
Despite all these gimmicks, (indeed because of them!) eurozone unemployment is at 8.4 percent, significantly higher than in the US. Such new restrictions will put a chill on investor ardor for risking money on Europe. By contrast, Europe's American competitors can quickly adjust the size and composition of their workforce.
It is bad enough that these burdens are imposed by national governments (e.g., high employment taxes, obstacles for laying off labor, barriers to competition, corruption), but additional layers of "federal" regulations are imposed by the EU. Consider actions by the European Commissioner for Competition, Mario Monti. Whereas, the EU Commission merger taskforce "only" interfered with 10 mergers in as many years, Mr. Monti has been especially active. A consensual relationship proposed by the bus and truck divisions of Volvo and Scania was deemed as promiscuous. Marriages between MCI-WorldCom and Sprint as well as General Electric and Honeywell were considered to be illicit. A watchful eye is being cast at the elopement of others.
Despite (incomplete) monetary unification, no single financial market exists in Europe. Consequently, Europe has few large private institutional investors who provide liquidity to capital markets or venture capital for local entrepreneurs and businesses.
This might be lessened if there were European-wide pension funds. However, national policies hinder such a practice, partly because many countries have retirement systems that remain under state control. With raising funds locally more difficult, large corporations have become increasingly dependent upon US credit markets.
In sum, the future is not bright for the euro. A consensus opinion is likely to form soon after the shiny new coins and crisp new bills begin to circulate. Once this logic works its way through markets, look for the euro to head sharply lower, perhaps falling to as low as US$0.50.
Christopher Lingle is global strategist for eConoLytics.com.
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