Sovereign debt worries are lapping around eurozone governments’ feet, European banks are facing a liquidity chasm, and economic confidence is treading water.
But can a sea of devalued euros save Europe?
After all, it’s been argued that the euro’s recent declines against the dollar will help exports offset austerity, even in Greece, and especially at parity levels.
Unless you look at the real effective exchange rate.
Carsten Brzeski of ING has done this, going back to October 2009 — and says that country divergence underlying the rate means euro weakness won’t actually do that much to help Europe’s worst-off sovereigns at all:
For the Eurozone as a whole, the real effective exchange rate dropped by slightly more than 11%. This drop masks a depreciation of more than 10% in Ireland and around 7% in Germany, the Netherlands and Finland. At the same time, the real effective exchange rate only depreciated by around 2% in Greece and Portugal and around 3% in Spain. Of course, real effective exchange rates are not the only determinants of export developments: think of product and regional specialisation, outsourcing or exporters’ hedging of exchange rate risks. Nevertheless, recent real effective exchange rate developments indicate that countries at the Eurozone periphery, except for Ireland, hardly benefit from the current euro weakness.
The chart below tells the story (click to enlarge):
What’s going on? As Brzeski reminds, it comes down to poor export fundamentals:
While exports account for more than 50% of GDP in Ireland and around 35% in Germany, they barely make up 20% of GDP in Portugal, 15% of GDP in Spain and only 5% of GDP in Greece. Same picture, different angle: while net exports have been an important growth driver in Ireland since the early 1990s, growth in Spain, Greece and Portugal has been driven almost exclusively by domestic demand.
Which may begin to explain we haven’t been worrying about the future sustainability of Ireland’s sovereign debt for the past few months in the same way as for Greece, where domestic demand is now a hostage to austerity. Hence analysts from Fitch to Barclays Capital are scratching their heads over where the growth will come from for a post-bailout Greece.
But fundamentals can be adjusted, right? Well, Brzeski is unsure:
To regain competitiveness a country needs to follow more deflationary policies than the rest of the Eurozone. Simply put, this means that countries such as Greece, Portugal and Spain would have to go through a protracted period with lower wage increases than in Germany. The German inclination for low wages clearly complicates such a task. In addition, historical evidence shows that the magnitude of the required adjustment is huge and almost unprecedented.
(Not coincidentally, German export confidence is just fine at the moment.)
Well, you could argue that there’s no point wasting a good crisis, and that the debt panic offers Greece et al. their best pop at reforming competitiveness for a while. At the same time, there’s been a recent and rollicking debate over at A Fistful of Euros over the actual merits of wage cuts — ‘internal devaluation’.
In any case — the last word goes to Brzeski:
The current euro weakness will benefit the countries which are already running ahead in the recovery and not the countries which need it most. There will be no quantum of solace from the euro.
Oh dear. The euro’s fall has left Europe’s South shaken, not stirred.
Related links:
Euro in crisis – FT / In depth
Eurozone growth starts to splutter – FT
Euro tea-leaves – FT Alphaville
Stimulus — nein! – FT Alphaville