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Irrational pessimism

НазваниеIrrational pessimism
Дата конвертации22.09.2012
Размер19.93 Kb.

The euro

Irrational pessimism


None of the explanations for the euro's weakness stand up

1:'VER since the euro was born, econo. J:, mists have been trying to come up with reasons for its weakness (down by 25% against the dollar since its launch in Janu' ary 1999). One by one, their theories have bitten the dust.

The first explanation was that Amer­ica's GDP was growing faster than GDP in the euro area, and so a fall in the euro against the dollar was both inevitable and desirable. Since March, though, America has been in recession. The latest forecasts suggest that the euro area will enjoy faster growth than America both this year and next. Still the euro remains weak.

Theory number two: productivity growth, and hence the profitability of in­vestment, is higher in America than in the

euro area. Alan Greenspan, chairman of the Federal Reserve, told a gathering of the Euro 50 Group in Washington last week that the weak euro reflected investors' expectation that America's productivity growth would outpace the euro area's in the years ahead. Rigid labour markets, he argued, make it harder to dismiss workers. Much of the return from investment in in­formation technology, he said, comes from cutting labour costs..

A recer.t Europear. Ccmrr3.ss1or. "'pm, on competitiveness appeared to confirm that America's productivity growth has been faster over the past decade. However, it used a flawed measure of productivity: GDP divided by total employment. In the euro area, average hours worked have fallen, so the measure understates true pro­ductivity growth. If instead one takes GDP

per hour worked, American productivity rose by an annual average of 1.6% in the ten years to 2000, but euro area productivity rose by 1.9%. Total factor prqductivity, which takes account of the efficiency with which capital and labour are used, also grew slightly faster in the euro zone than in America.

The notion that American productivity

leaves Europe's behind is based on perfor­mance over the past five years-which was partly inflated by an unsustainable invest­ment bubble. Europe needs structural re­form, but low productivity growth is not an explanation for the euro's weakness.

Popular explanation number three is that investors have more confidence in the Fed than in the European Central Bank

(ECB). It is argued that the ECB focuses to excess on price stability and not enough on growth. A paper presented at the Euro



~ 'it!

Corporate pnJfits tnAmerica'

^ What dothitprofit?

finance and econotnjC$; 71


Corporate Americais seeing an unusually severe slump in profits



OnnNG contributes so much to

. theprosperityandb:appiness of

a country' as highpidfits," proclalmed

Davia Ricardo; an earlY"19tll~~e1itury economist.. I(so, AInerica ism a mis,er~

, ablestlte:corooiate DIofitabifitV.has fall

to iero'over i:1ufndttW.o quarters;which . will put even more pressure on profits. Wages, wbIcli make uptwo-mmis of ro­~ costs, typically moye down only re­


The' j,;9.%-jump'JrH:bfisumerspei1diriw' in O(;tooer;the.biggesfilid~ase on te-'

cord, b.r6ughfcheef'ro:thosebetting on a strong ec§~~¥ni~recoY~ty. Tb:e jump,

though; largely ie~e~te'daggressfve dis­counting; es,peciaIlyfiy Cal makers and retailers. Discouiits IIi~y boost volume,

but at a high j:osf to J>(jfit ~argins. '

Stockmarketsra:ijied ~trongly this

50 Group meeting by Antonio Borges and Francesco Giavazzi questioned this. One rule of thumb for monetary policy is the "Taylor rule", where the "correct" interest rate is derived from forecasts of inflation and the current size of the output gap. Judged against this rule, the authors con­clude that the ECB'S policy has not been noticeably tighter than the Fed's. America has required more rate cuts because its economy has slowed more sharply. The Taylor rule is sensitive to assumptions, but these findings suggest that popular criti­cisms of the ECB are too crude.

A fourth theory is that the dollar has be­come a "safe haven", so that when inves­

week in hope that economic recovery, anq hence higher profits, is around the conrer. But even if the economy furns round. eariyriext year, a strong rebound in growth is unlikely so long as firms are

,sa9dled with excess capacity. And as long as nominal GDP growth remains

. . subdued, so tOQ will be the growth in ptofits. That means that sfoqinarketin­vestors are'likely to be disabused, and

';iilso that firms will be under pressure to improve their finances by making fur­ther~Guts in investment ana jobs. And that could prolong the recession.

Stockmarket bulls point out that pro­ffiJ
. ductivity growth and profits is more complicated, however. Over the past three years, as productivity growth has quickened, profit margins have actually fallen. As with earlier technology revolu­tions, the lion's share of the spoils from information technology is going to con­sumers, not producers.

tors become more risk-averse, they pile into dollars. Should America suffer a deep recession, this hurts the world economy as much, if not more. So, it is argued, more risk-averse investors will buy dollars. Should America have a strong recovery, they will buy dollars too. The dollar, in other words, is strong because investors expect it to be. That is a worrying basis on which to make investment decisions.

A better explanation of the euro's weakness may be that it started life over­valued, and then overshot in the opposite direction. Most theories assume that for­eign-exchange markets are entirely ratio­nal. A curious starting-point. .

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