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They’re now calling him ‘le piranha’. Fresh from attacking the notion of free competition in the EU, French president Nicholas Sarkozy honed onto a new target last week. The European Central Bank (ECB).
Worried that a stronger euro is damaging the French economy’s competitiveness, he called into question the bank’s independence, and its focus on inflation rather than economic growth.
Thankfully, Europe’s finance ministers promptly told him to shut up.
That’s because the euro’s ascent has more to do with the weakening US economy than a resurgent European one…
The euro may well have strengthened against the dollar, but so too has sterling – by about 4% in 12 months. That’s because investors, wary about problems in the US subprime housing market and the effect it could have on the rest of the country’s economy, are switching assets. Out of dollar-denominated ones and into those priced in sterling, and euros.
So there’s little the European Central Bank can, or indeed, should do. Just look at what happened in the markets on Wednesday. Bear Stearns admitted that its two sub-prime focused hedge funds were virtually worthless, and the dollar hit a new all-time low of $1.3833 against the euro, and a fresh 26-year trough against the pound at $2.0548.
As Ambrose Evans-Pritchard points out in an excellent column in this morning’s Telegraph (you can read it here, it’s well worth the detour – particularly if you want to know why the pound’s strength will be short-lived: Beware the Dutch Disease) none of this means that the UK or Europe has discovered the secret of ever-lasting wealth – it’s got more to do with American monetary mismanagement coming home to roost.
Nevertheless, the strong euro has got Sarkozy worrying. In making French products more expensive, the currency’s potency is also making them less competitive. Which is part of the reason why exports are down 18% since it joined the euro in 1999, and the French trade deficit has widened. From a surplus of €5.2bn five years ago, to €27.6bn today.
But if French manufacturing is beginning to feel the woes of a stronger euro, why isn’t Europe’s other major economy, Germany? Germany’s share of world trade has in fact risen – it’s now the world‘s biggest exporter.
So what’s Germany’s secret? The answer is simple – a combination of half-hearted government reforms, and far more ruthless and effective reforms driven primarily by companies and workers, who realised that something had to give for the sake of all their futures, has made Germany an excellent place to do business.
Structural reforms began under former Chancellor Gerhard Schroeder, when the government cut unemployment benefits to people who had been without a job for more than a year. Employment levels began to pick up as German companies agreed radical labour agreements with their members. Employees would have to work longer hours for no extra pay as a means of keeping costs down, and boosting productivity – a big change from the 35-hour week first introduced there in the 1980s (and still a feature of French law). Just recently, Deutsche Telekom workers agreed to work an extended workweek and a pay cut in order to keep their jobs.
The results have been very positive. Labour productivity in Germany increased 2.2% last year from 2005, says the OECD, against just 1.2% in France. Relative unit labour costs (hourly labour costs adjusted for productivity) have fallen 10% since 2003 compared with the rest of the OECD. And unemployment has fallen from a high of 9.5% to 6.4%. In France, it’s 8.6%. Overall, Germany has gained 22% in cost competitiveness against France since the launch of the euro.
Indeed, Germany can now afford to cut corporate tax from 38.7% to 29.8% at the start of next year and start raising wages. Deutsche Bahn recently agreed to a 4.5% wage rise, the biggest in the company’s history.
So there’s a lot that France can do, other than bleating to the ECB that they should lower rates. The Portuguese Finance Minister Fernando Teixeira dos Santos said as much this week. “Let’s not fall into temptation to resolve our economic problems by devaluing. If we want to gain competitiveness it’s not by devaluing our currency,” he said. Rather, EU countries should instead focus on improving their productivity and competitiveness.
Luxembourg’s prime Minister, Jean-Claude Juncker, agreed. “Countries unhappy with the current exchange rate” should implement structural reforms, he said, “so that their sub-system of the eurozone becomes more competitive.”
That doesn’t mean that the French will give up. Sarkozy is keen to draw allies in his desire to effectively wrestle control of interest rates and exchange rate policy from the ECB – which is possible under the Nice Treaty, according to Evans-Pritchard. But the chances of Germany agreeing to this are nigh-on non-existent.
The very idea of cutting rates right now is anathema to the Germans. Start cutting rates now, just as the economy is getting resoundingly back on track, and inflation will start creeping in. The Germans of course, know a thing or two about inflation. The experience of loading wheelbarrows with cash in the 1920s has had an everlasting impact on the country’s consciousness. So we suspect Angela Merkel would rather leave the euro than see the German economy wrecked by spiralling inflation.
“The population should be protected against inflation. This is very important. That is why the independence of the European Central Bank is the alpha and omega. And that is why Germany will not budge on this,” Merkel said on German TV recently.
Sarkozy may have more than a few allies in the eurozone – there are plenty of countries, Spain for one, who would rather see rates fall than rise. But will France – a key architect of the European project, let’s remember – genuinely be willing to bring down the euro to gets its way on rates?
We’ll have to wait and see. But there’s one piece of news that should help bankers at the ECB sleep a bit easier at night. Last month, scientists revealed that the piranha wasn’t as ferocious as once thought. Its teeth were bigger than its bite. Never has a nickname been more appropriate.
Turning to the wider markets…
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Miners and financials led the FTSE 100 to a positive close yesterday. The index of leading shares added 73 points to end the day at 6,640 and the broader indices were also higher. For a full market report, see: London market close
On the Continent, stocks also ended higher as Wall Street rallied yesterday. The Paris CAC-40 was 69 points higher, at 6,065, and the Frankfurt DAX-30 was 97 points higher, at 7,991.
Across the Atlantic, the Dow Jones added 82 points to close at the 14,000 mark for the first time ever. IT stock IBM led the way having reported its best quarterly performance since 2002. The tech-laden Nasdaq was 20 points higher, at 2,720, and the S&P 500 was 6 points higher, at 1,553.
In Asia, the Nikkei was up 41 points to 18,157 today and the Hang Seng was as high as 23,291, a 275-point gain.
Crude oil had risen to $76.03 this morning and Brent spot was at $78.96 in London.
Spot gold climbed as high as $677.30 in New York late last night on the back of the weak dollar, but had slipped to $676.50 this morning. (For in-depth daily gold reports, see: investing in gold. Silver, meanwhile, had fallen to $13.27.
In the currency markets, the pound was at 2.0511 against the dollar and 1.4873 against the euro this morning. And the dollar was at 0.7249 against the euro and 122.31 against the Japanese yen.
And in London this morning, the Office for National Statistics revealed that UK GDP growth picked up in the second quarter, suggesting that interest rate hikes have failed to cool expansion. GDP was up 0.8% compared to 0.7% in Q1.
And our two recommended articles for today…
The three things that could end this bull market
– Those who try to call the top or bottom of a market usually get it wrong, but that doesn’t mean you should stand idly by and wait to see what happens. Marc Lichtenfeld reveals the key factors to watch out for plus how to prepare for the coming storm: The three things that could end this bull market
Ten of the best investments in Europe
– If reading about Germany’s resurgent economy has piqued your interest and you’re eager to get out of US equities, then this recent MoneyWeek roundtable is for you. We gathered together five investment experts and asked them for their views on the European market – including their top share tips. For ten of the most promising European equities around, click here: Ten of the best investments in Europe