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Pumped Up and Proud of It

5 minute read

As the euro has soared against the dollar over the past three years — it’s up more than 40% since 2002 — European leaders have been trafficking in gloom and doom. Politicians gripe about the damage to their national economies. France’s new Finance Minister, Hervé Gaymard, last month called the dollar’s decline “very worrying” and said Washington needed to fix the problem. And German trade groups sound more like self-help gurus when they talk — as they frequently do — about the currency crossing “a pain threshold.” But despite all the whining, the strong euro has been a considerable boon to Europe’s economy.

Call it the Jane Fonda school of economics: no pain, no gain. As in any good workout, the stretching of the euro has forced flabby European companies to become fitter. Since the rising euro means euro-zone goods sold abroad cost more, competitiveness has taken a blow, but not a brutal one. In Germany, for example, overall competitiveness has declined by only about 6% — far less than the dollar’s depreciation — according to the Paris-based Organization for Economic Cooperation and Development. How come? For one thing, Germany and the other 11 euro-zone nations now have a much bigger internal market to sell to without exchange-rate risks, and some of the zone’s important trading partners, including Britain and Switzerland, haven’t suffered U.S.-style currency falls.

But companies have also played a key role: to stay competitive, most European firms haven’t raised prices in the U.S., Latin America and Asia. That’s put ever greater pressure on them to reduce production costs, come up with innovative products and push into new markets — with outstanding results.

Consider Renault, the 106-year-old French automaker that a decade ago was heavily indebted and still majority owned by the state. It has moved to become more international, and now sells more autos outside Europe than it does in France. Its latest model — the 5,000 Logan, built in low-cost Romania — is aimed at the aspiring middle classes across the globe. Renault recently announced its earnings for 2004: record net income, operating profits up 72% and profit margins at almost 6% of sales — more than double Ford’s.Renault’s success is no fluke. Germany has defied the conventional wisdom that a rising currency hurts exports; German exports surged 10% to a record high last year. And that’s not just demand from China; exports to every region, including the euro zone itself, were up. There are other positive signs, too, including the percentage of the economy derived from business income, a key indicator of whether corporate output is rising or falling. After a lackluster few years, the percentage has shot up in the past 12 months in several E.U. nations, including Austria, Finland, Ireland and the Netherlands. In Germany, business income surged to 23% of GDP last year, well ahead of the 21.9% seen during the corporate boom of the late 1990s. And for those companies that are too small or too fainthearted to do business overseas, the removal of exchange-rate risk has been a real blessing. Intra-euro trade has increased by about 20% since 2002, and it’s an important buffer against the dollar’s decline.

National governments, too, are benefiting, as private-sector gains in efficiency and productivity raise the pressure to overhaul restrictive or anticompetitive policies. The French Parliament this month finally buried the 35-hour workweek, and Germany has overhauled its unemployment-insurance system. Elected officials may well fear the political fallout from such dramatic moves, but in the medium- and long-term their economies — and maybe even their voters — will thank them. Financial markets are also feeling the impact as central banks in places like Russia are shifting more of their reserves into euros. After all, who wants to keep buying assets that lose value?

Yes, there’s a downside. A strengthening euro leaves little margin for error. When profits are being squeezed, bad investment or strategy decisions can be fatal. European bankruptcies are still on the rise. And Federal Reserve Chairman Alan Greenspan this month warned that European firms won’t be able to swallow their profits indefinitely — they’ll have to raise prices or pull out of the market altogether. But perhaps the biggest loser is the European consumer. Because of restrictive pricing laws in most of Continental Europe — and the reluctance of retailers to sacrifice profits — savings from imported goods priced in dollars have not been passed on. Many of the hottest American items, from the Apple iPod to Gap jeans, still cost far more in Europe than they do in the U.S. That’s a shame, since what’s hurting Europe’s economy most is weak consumer demand. Some well-hyped price cuts — these savings are brought to you courtesy of the strong euro — could be just what the Continent needs to get truly back into shape and stay there.

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