Beware of false arguments: The strong euro will hurt

In the economic policy debate, Germans tend to extrapolate their current situation indiscriminately into the future. When the economy hardly grew at all in 2002 and 2003, German economists and journalists were quick to estimate potential growth to be “below 1 percent”. Now, with exports having grown strongly over a number of years, it is argued that the strong euro will not hurt German exporters even at a level of 1.60 $. Unfortunately, the arguments for complacency towards the euro are as dubious as those on the structural inability of the German economy to grow were five years ago.

The best example for the view of the German export sector being made from teflon and thus invincible to a higher exchange rate comes from my former colleagues at FT Deutschland which last week published a whole page under the heading “Gute Zeiten” (“Good times”). [Note: The euro optimism is not limited to FT Deutschland – other papers do it as well. However, the FTD piece had all the arguments most nicely summed up, but they creep up in editorials from the FAZ to the Handelsblatt.]

Basically five arguments are usually brought forward why the appreciation is harmless from a German point of view:

  1. German exports are so unique that the demand for them abroad is highly (or totally) price inelastic. Experts now often cite the capital goods industry, the FT Deutschland had an example of a company making cuckoo clocks.
  2. More than 40 percent of German exports are sold to our partners in EMU and hence not influenced by the euro exchange rate.
  3. About 80 percent of purchases outside the euro area are factured in euro.
  4. 75 percent of the exports are hedged.
  5. German manufacturing profits from lower oil prices as they are denominated in dollars which in turn helps them to remain competitive in the world market.

However, looking at those four arguments more in detail shows that all this might contribute to some lag between the euro appreciation and the moment when the export sector feels the pinch, but none of them really lets one conclude that the German economy is immune to the euro:

  1. Even if German products are rather unique, I find it quite implausible that demand for them is supposed to be totally price inelastic. The depreciation of other currencies not only leads to a price effect of German exports, but also to an income effect: If they have to spend more on imports thanks to the lower dollar exchange rate, they have less real income. I cannot think of any product the demand for which is both inelastic with regard to its price and with regard to the buyer’s income. Moreover, if demand for German products is that price inelastic, one should ask why German exports did so much worse than today in the 1990s. Did German companies sell entirely different products then? In addition, if export firms can keep their sales volumes and market shares up regardless of a 20-percent price increase, why haven’t companies increased prices when the dollar was weak which could have boosted their profits? Is German corporate management really that incompetent not to notice that demand for their products is price-inelastic?
  2. Even if 40 percent of German exports go to the rest of EMU, this does not mean that these exports are immune to a strong euro. First, German products sold in France of course compete with imports from the US into the French market. Second, if the Spanish or French economy slows due to the euro appreciation, demand for German products there will also be hit.
  3. Even if 80 percent of German exports outside the euro area are invoiced in euro, there still will be the price effect. Of course, the exporters do not lose money on the goods already ordered. But demand in the future will certainly be weaker (see above).
  4. The hedging: Yes, at the moment, 75 percent of the exports might be hedged. But the nature of hedging is that you cannot do this too far into the future, meaning that most companies have not hedged their revenue further than maybe into 2009. And if you now try to hedge some sales for 2009, your bank or counterparty will take the current level of the euro-dollar exchange rate into account.
  5. Measured in euros, German manufacturing firms may pay less for their oil. But this doesn’t matter for the question wether you gain competitiveness relative to US companies. Everyone is paying the same for oil in dollar terms. An depreciation of the dollar just makes the additional value added in EMU more expensive than that in the US. Hence, EMU companies lose competitiveness. You cannot discuss this point away.

This all does not mean that an economy might not thrive in face of an appreciation of its currency. We have seen in the US in the past decade that an economy can grow briskly even in face of a strong currency if domestic demand is growing strongly. However, exactly this is not yet the case in Germany. It is very hard to imagine a situation where the export sector is immune to a strong appreciation. No matter what the optimists are saying now, at some point, the strong euro will come back to haunt the German manufacturing sector.

This post has been co-posted at Eurozone Watch.

7 Responses to "Beware of false arguments: The strong euro will hurt"

  1. Guest   March 24, 2008 at 3:20 pm

    1. “if export firms can keep their sales volumes and market shares up regardless of a 20-percent price increase, why haven’t companies increased prices when the dollar was weak which could have boosted their profits? Is German corporate management really that incompetent not to notice that demand for their products is price-inelastic?”An important question never discussed, which makes one wonder if the newspaper economists ever ran a business. In addition, was and is not the need of “making Germany more competitive” the main reasoning given for structural reforms leading effectively to lower wages? Why are such painful (and politically difficult) changes necessary if the rest of the world does not mind paying whatever price for German products?3.+4. If 80 percent of German exports outside the euro area are invoiced in EURO, why are 75 percent hedged? Against what?The more likely scenario is that the mass of smaller and medium sized enterprises (which usually don´t count much except in Sunday speeches) have less or no hedging, and are usually the least able to dictate prices or the invoice currency. Big internationals on the other hand hedge best by boosting production in their North-American facilities, which (showing up in statistics with some delay) will have consequences for their European counterparts.Current export optimism is based on belief. It worked the last couple of years, so why no longer? The thought that it may just be a bubble fed by bubbles in the U.S. and emerging markets is probably too ugly to be thought, as it touches on German self-esteem, and may actually involve facing the idea that the celebrated AUFSCHWUNG was not homemade.

  2. Guest   March 26, 2008 at 7:17 am

    “3.+4. If 80 percent of German exports outside the euro area are invoiced in EURO, why are 75 percent hedged? Against what?”If I remember that article from FTD correctly, the point was that 75% of those exports not denominated in € are hedged.

  3. Sebastian Dullien   March 26, 2008 at 9:49 am

    Yes, of course it means that 75 percent of those not denominated in € are hedged. If I misrepresented the FTD article, I have to apologize!

  4. Anonymous   March 26, 2008 at 12:58 pm

    The Euro is not the only currency which has appreciated against the USD. The JPY, SFR, CAD have all appreciated against the USD, some of them have appreciated even *more* than the Euro.Probably the only major currency which has appreciated much *less* against the USD is the Renminbi, due to government intervention.We are talking about a weak USD, not about a strong Euro.Thus, it does seem plausible that the weak USD won’t hurt German exports: Only the exports to the US (and probably China) suffer, whereas exports to Japan, Switzerland, Canada, and others can remain strong.

  5. Guest   March 26, 2008 at 1:39 pm

    The FTD pieces actually tell us as the main “secret” of BASF, Linde, Gea or ZF Friedrichshafen: “Producing increasingly where the customers are”. German machines produced in America – can this really serve as an example of EXPORTS? Does Germany have a reason to welcome such developments?The 80 percent in Euros / 75 percent hedged numbers originate evidently from a survey done by the IFO institute. Do they consider the “long tail”?

  6. Guest   March 26, 2008 at 1:47 pm

    Anonymous mentioned: “Only the exports to the US (and probably China) suffer.”The past years they were celebrated as the main markets.Add UK (property and consumption bubble) and Spain (property and consumption bubble) to the slowdown, and compare it to a list of Germanys best importers…

  7. sbo78   March 26, 2008 at 10:02 pm

    Very nice commentary – came across it after reading the actual Herdentrieb entry ( ) and commenting in similar, although much more theoretical arguments. If people wonder, why German economy is seemingly doing so well, two facts are easily overlooked:The German economy increased its competitiveness over the last decade by more than 10% relative to other Euroland economies. This was achieved by earnest reforms and by simple cuts in real income of the employed. This increased competitiveness gives some immunity to a strong Euro (as opposed to France or Italy which are facing real troubles).A big part of the German export business is in capital goods designed to produce. This specific branch of the world economy always has to follow business cycles with a certain lag, because investment usually lags behind economic upswing. And subsequently, production of outstanding orders ensures stable growth a short while into a recession for these enterprises.As can be reasoned from these observacions, the current German boom won’t last forever and follow the world economic trend with a certain lag. Be it the USD/EUR exchange rate or the slump of the world economy: what goes up must come down…