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It’s the European Central Bank’s 10th birthday party. But not everyone is celebrating…
It’s set to be a bubbly few hours in Frankfurt this Monday. The European Central Bank (ECB) is ten years old this weekend, and the bureaucrats at its German HQ have planned quite a party. After the various eurozone finance ministers gather for the traditional ‘family photo shoot’, “there will be some speeches, the cutting of a 10th birthday cake and then a closing concert”, says Raphael Anspach, a spokesperson for the ECB, rather enthusiastically. Sounds fun.
But before the string section pipes up, we recommend that the organisers have a think about sticking a cork in the trombones. The second ten years are going to be a lot less triumphant than the first ten…
When the euro fell to 90 cents to the US dollar in the early 2000s, it was derided as a ‘toilet currency’ by nationalistic curmudgeons and currency traders alike. One single currency, it was thought, couldn’t possibly represent a jumble of nations on different economic cycles, not to mention a cacophony of countries with wildly divergent industrial bases and monetary needs.
The hidden weaknesses of the euro countries
How things have changed. The euro is up 60% against the US dollar since George Bush first came to power, as both Gulf states and Asian countries have begun ditching the greenback for safer stores of value. And the euro’s share of global foreign currency reserves rose from 18% back in 1999 to more than 25% by 2007. But that doesn’t necessarily mean that the fundamental position of the euro is any better than it was eight years ago. Investors may have fled the US dollar, and watched the eurozone grow relatively fast against its lagging American counterpart, but they’ve ignored the hidden weaknesses on this side of the Atlantic.
This year’s first-quarter GDP growth across the eurozone flipped up a good 0.7%, but that figure was skewed upwards by the rollicking performance of the German economy. German GDP growth climbed 1.5% on the back of a roaring manufacturing base oiled by booming exports. In contrast, Italy only managed expansion of 0.4% and Spain 0.3%, while in Portugal, growth actually fell by 0.2%.
Meanwhile, inflation is on the rise, led by a good 4.6% in Spain and 5% in Ireland. Both are well outside the ECB’s 2% target. The spectre of stagflation – a stagnant economy plus rising inflation – is rearing its ugly head. Indeed, “stagflation is a situation that we experienced some years ago, it could return,” said Spain’s Economy Minister Pedro Solbes earlier this month.
Why a strong euro is disastrous for Ireland
And that’s not the only problem. A strong euro might be good news for Germany, given the strength of its economy, but for Ireland, whose main export destinations are the UK and the US, it’s disastrous. Ireland has begun to lose its competitive advantage against other destinations for multinational companies, says Professor Rodney Thom, head of the School of Economics at University College Dublin, as it becomes more expensive to export pricey euro-denominated goods and services abroad.
“I never saw any advantages to us joining the euro”, says Professor Thom. “The last thing we needed was low interest rates when the economy was overheating”, and now that the currency has risen against sterling and the US dollar, “we’re losing our competitive edge. Ireland is on a limb”, he says, because it has given up one of the most significant economic levers open to any country – the ability to set its own interest rates.
In the 1990’s, when sterling depreciated 5% against the deutschmark, “the Irish central bank did something very clever”, he says. It let the Irish punt depreciate half way between the two currencies “to keep a balance. Now we can’t do that. The euro has given us a headache that we didn’t need.”
So there are plenty of things for Europe’s finance ministers to think about when they’re quaffing their champagne and gobbling their cake this Monday.
Turning to the wider markets
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UK shares improved slightly yesterday with an 11 point flip up to 6070, after a better session on Wall Street. Bank stocks were weaker as analysts cut earnings forecasts, with Lloyds TSB down 2% and Barclays 1% lower. Tate & Lyle lost 2% on a Goldman Sachs’ target price downgrade. But British Airways rose 1.6% despite doing ‘xd’, while Easyjet soared 6% on share buying by the chief executive.
European markets were firmer, with the German Xetra Dax picking up 0.8% to 7034 and the French CAC 40 advancing 1.3% to 4971. In contrast to London, bank shares improved on the day.
US stocks closed higher for the second successive day, with the Dow Jones Industrial Average closing up 0.4% at 12594. The wider S&P 500 also gained 0.4% to 1391, while the tech-heavy Nasdaq Composite nudged up 0.2% to 2487.
Overnight, the Japanese market enjoyed a strong rally, with the Nikkei 225 climbing 3% to close over 400 points better at 14124; while in Hong Kong, the Hang Seng added 0.5% to 24384.
Commodity prices were mixed. Brent spot was trading this morning at $130, while spot gold dropped to $898. Silver was trading at $17.37 and Platinum was at $2045.
In the forex markets, sterling was weaker against the US dollar at 1.9714 but firmer against the euro at 1.2666. The dollar was generally stronger, trading at 0.6425 against the euro and 105.21 against the Japanese yen.
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