San José, Costa Rica, since 1956
Dollaz

This is why the euro is collapsing

WASHINGTON, D.C. – For those in the United States, the next summer is looking like the best time to take that European vacation you’ve been thinking about. That’s because the euro has already fallen to a 12-year low of $1.06, and should keep falling for at least another year. In fact, it shouldn’t be long until the dollar is worth more.

A brief history 

The last time the dollar was worth more than the euro was all the way back in December 2002, just three years after the common European currency came into existence. But in the years after that, the euro gained strength as the continent imported less and exported more. The euro soared to an all-time high of $1.59. It was enough that, in 2007, former U.S. Federal Reserve Chair Alan Greenspan wondered if the euro would replace the dollar as the world’s reserve currency — in other words, the benchmark that everyone uses in case of emergency. Even supermodel Gisele Bundchen reportedly insisted on being paid in euros rather than dollars. That’s quite a consensus. But it turns out that these reports of the dollar’s death were greatly exaggerated. Since then, the euro has fallen 24 percent against the dollar in less than a year, and made everyone forget its grand ambitions.

Even supermodel Gisele Bundchen reportedly insisted on being paid in euros rather than dollars.

Timothy A. Clary/AFP

What happened? 

Robert Frost can help us here. Two monetary policies have diverged in, well, not a wood, and Europe has finally taken the path well traveled by. Specifically, to boost Europe’s extraordinary weak economy, the European Central Bank (ECB) is buying bonds with newly printed money, aka quantitative easing, while the Federal Reserve is far enough along that it’s getting ready to raise rates. That means interest rates are falling, sometimes into negative territory, in Europe, and, at least on the short end, rising in the U.S.

Think about it like this. Would you rather buy a German 10-year bond that pays 0.25 percent or a U.S. 10-year bond that pays 2.1 percent? Investors, especially big European ones, are answering that by moving their money out of euros and into dollars. And voilà, the euro has fallen from $1.39 last year to $1.06 today.

The simpler way to think about this, though, is that the U.S. economy is in a lot better shape than Europe’s. Unemployment is 5.5 percent here and falling fast, while it’s 11.2 percent there and barely falling at all. Now a stronger economy should mean a stronger currency, because it needs higher interest rates to keep inflation in check — which should make it a more attractive place to put money.

But, as Europe has found out, the opposite isn’t true. Higher rates don’t make your economy strong if it’s actually weak. And even though that will push your currency up in the short run, it will make it fall even more in the longer one. That’s the mistake the ECB made — twice, actually! — in 2011, when it raised rates to fight some fleeting oil inflation. The result was a double-dip recession that almost tore the common currency union apart, and has only just ended. To make up for that, the ECB has had to do more than it otherwise might have, cutting interest rates into negative territory and buying €60 billion of bonds a month. The euro, in other words, is falling so much more today, because it didn’t fall like it should have yesterday.

The U.S., meanwhile, has been printing money like it should have, at least most of the time. It started Quantitative Easing in 2008, expanded it in 2009, restarted it in 2010, and re-restarted it in 2012 with a promise to keep going until unemployment came down. It worked. Now all these starts and stops are why the dollar kept going up and down and up again these past few years, but now that it’s over, it’s only going up. Indeed, the Fed is done buying bonds, and, unlike almost every other central bank, is preparing to raise rates. That’s pushed the dollar up against every currency, but especially the euro now that the ECB is printing them.

The Fed is done buying bonds, and, unlike almost every other central bank, is preparing to raise rates.

Brendan Smialowski/AFP

How low will the euro go?

That depends on how much, if at all, the Fed raises rates, and how long the ECB buys bonds. On the one hand, there’s no sign of any inflation or bubbly behavior that would force the Fed to raise rates. But on the other, the Fed has been pretty clear that it wants to start normalizing policy in June because unemployment is already normal-ish. And on top of that, New York Fed President William Dudley has even said they might have to hike rates in quick succession if long-term rates don’t go up too — which seems pretty likely with Europe’s low bond yields pushing ours down. The ECB has promised to keep buying bonds until at least September 2016, and even longer than that if inflation is still too low. Now Europe’s inflation numbers are already picking up a little bit, but, as The New York Times’ Paul Krugman points out, markets seem to believe it will be a good while longer before Europe’s economy — and by extension, its monetary policy — is anywhere close to normal. Add it all up, and Deutsche Bank expects the euro to keep falling to $0.90 by the end of 2016 and $0.85 by the end of 2017.

So now you know when to buy those plane tickets.

O’Brien is a reporter for Wonkblog covering economic affairs. He was previously a senior associate editor at The Atlantic.

© 2015, The Washington Post

Log in to comment

Steve

Actually john it has gone up on most currencies. God your a nit picky person, while There are actually only a handful that it has remained flat or lost ground. But nobody really cares about the small country currencies. The dollar has gone up against the Pound,Euro,Yen,Chinese yaun,German Mark, Australian dollar. The ones it has been loosing ground on are typically countries with bad ties to the U.S and their governments control the exchange just like Costa Rica was doing when the dollar was weak. They held the value up in order to keep businesses profitable here. That was actually a good thing. These currencies will change eventually as long as the dollar performs well. But to say it’s because the other currencies are weakening is extremely one way. So when the Pound and euro got strong it was actually the dollar getting weak? So no currency ever gets stronger it’s always the other currency that gets weaker? Of course people that have dollars want it to be strong don’t act like your any different. With a strong dollar the prices of everyday amenities here drops. It’s kind of a no brainer dude. Sure the dollar didn’t go up against every currency, However it did make gains against nearly every currency that matters as far as economic leading countries. You really hate Americans don’t you john? You love to throw Gringos under the bus alot?

0 0
John

This story’s claim that “That’s pushed the dollar up against every currency” is factually untrue.
The US dollar hasn’t gone up against EVERY currency
It has gone up against those major ones we are used to measuring it against (the pound, the Euro, the Canadian dollar, etc.)
To be further fair about this, it may be more that those currencies have weakened, rather than the US dollar has strengthened.
If you check the dollar against some of the world’s other 180-odd currencies in the past year, it’s easy to find some the dollar has not gone up against.
I did this just now out of curiosity by randomly looking on the currency-tracking website http://www.xe.com (they also have a currency app) and here’s what I found:
In more or less the past year, the dollar has actually gone down slightly not only against the Costa Rican colon, but also against the Guatemalan quetzal.
Against some others, it has also gone down or remained about the same: ex.- Dutch guilder, Bangladesh taka, Belizian dollar, etc.
If you go back four years as a starting point, the colon’s value today would be lower.
The colon’s current strength does seem to bother some gringos, who see it as some sort of nefarious Costa Rican plot to separate them from their US dollars. But that’s maybe just our always wanting our money to be worth more than other countries’.
To make the exercise even more complicated, you can choose comparisons of various time lengths (two years, five years, 10 years) and this will suggest other conclusions.
One lesson here would be to beware of generalizations, and to check statements which claim to support them.

0 0
SirVivor

“That’s pushed the dollar up against every currency …”

Except for the colon … for now.

0 0