Heading for parity

Jan 17th 2015

A tumbling currency reflects Europe’s dismal prospects; it is a second-best route to curing them 

THIS week marked a milestone in the history of Europe’s single currency. On January 14th the value of the euro slipped to $1.17, the rate at which it was introduced on January 1st 1999. BackQ then, the fledgling currency weakened fast, hitting parity with the dollar in early 2000 and plunging to $0.83 by October of the same year. The slump in the euro’s value suited no one: the European Central Bank (ECB) worried about inflation from rising import prices; other countries fretted about declining competitiveness. So the world’s big central banks undertook a programme of co-ordinated intervention to stem the euro’s fall.

This time round the euro’s slide has been more gradual, but it is likely to prove more persistent. Parity with the dollar is quite plausible this year. Both politics and economics are undermining the currency.

The immediate threat is from the political side—and uncertainty about the consequences of the Greek elections on January 25th. The damage of Grexit, though lower than in 2012, would still be huge (see article). At the moment, such an event seems unlikely. Syriza, the far-left party that looks like winning the largest number of seats, insists it wants to stay in the currency (as do the vast majority of Greeks). Germany’s government, too, is full of soothing noises about the inviolability of the euro. Nonetheless, the risks of an accidental exit are uncomfortably real. From a higher minimum wage to a halt to privatisation, the policies that Alexis Tsipras, Syriza’s leader, is proposing will worsen Greece’s public finances—and require more sleights of hand to keep Greece in conformity with the rescue packages that determine its ability to stay in the euro (see article). Even if Greece stays in, wary investors may decide to ditch their euro exposure, pushing the single currency down further.

More important are the economic fundamentals and the plausible European policy responses. Deflation has set in (prices across the single-currency area fell by 0.2% in the year to December) and, with Germany’s economy wobbling, the region’s growth prospects look ever feebler. Yet despite the darkening picture there is no sign of boldness from politicians. There are no big ideas to kickstart the single market or to boost investment. Instead, all eyes are on the ECB and its willingness to create money to buy sovereign bonds.

On January 14th a preliminary decision by the European Court of Justice declared the buying of sovereign bonds by the ECB to be legal. This should make it easier for the central bank to begin a programme of large-scale bond purchases. Such quantitative easing (QE) could start before the end of the month. In America QE helped boost share prices and drove down borrowing costs for companies. Given the underdeveloped state of Europe’s capital markets, the main way QE is likely to banish deflation is through a weaker euro. Imports will cost more while exporters—and the economy—will get a boost.

Parable of weakness past

QE would be better than no QE, both for Europe and the rest of the world. Everyone would gain if the euro area avoids a renewed descent into crisis. But if the euro falls even further, Europe will most likely come to rely ever more on exports for its growth. The region already saves a lot more than it invests: thanks to Germany’s insistence on austerity in peripheral economies and its refusal to boost investment at home, the euro area’s current-account surplus has surged to 2.5% of its GDP. That is a huge shift: for most of the single currency’s 16-year history, the region was in balance. If the euro falls to parity with the dollar even as domestic spending stays weak, that surplus is likely to grow larger still. At some point the currency’s weakness will cause tensions with others, particularly the Americans.

The euro’s rise and fall is a sorry parable, whose lesson is the cost of avoiding hard choices. When times were good, Europe’s leaders avoided structural reform. In the crisis, they always did just enough to stave off disaster, but not enough to avert deflation and stagnation. A weaker currency will help, but is far less good than a balanced European recovery based on healthy investment and spending at home