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Euro Loses Strength As Eurozone Recession Deepens

  • Charles Recknagel

On New Year's eve, there seemed to be every reason for the eurozone to feel grateful it has a single currency.

The euro, which started life a decade earlier worth $1.18 had proven it not only could hold its own against its rival but pull investors away from it.

The euro's value as the fireworks lit up the midnight sky was $1.39.

But now, as the eurozone looks as fully stricken by the recession as America, the mood regarding the euro is changing. And some investors are fleeing.

On February 17, the euro dropped more than 1 percent before settling at $1.26, where it was still hovering two days later.

The plunge came as global investors digested the news that eurozone banks -- already hard hit by loan defaults in the collapsed U.S. and Western European housing markets -- could face still more losses.

This time, the losses are expected to come from Eastern Europe where eurozone banks have loaned $1.5 trillion to businesses and consumers over the past decade and-a-half. Any defaults on those debts would particularly weaken Austrian, Swedish, Greek, Italian, and Belgian banks -- further deepening the credit crisis now paralyzing Europe's business world.

But it is not only these latest headlines that are frightening investors away from the euro. Many financial experts worry the eurozone itself has sunk into a recession every bit as deep as America's, and one that might last longer.

"Just two months ago, or three months ago, many observers were thinking that the United States was particularly exposed to the financial downturn and that the eurozone countries would come off somewhat lightly, that they would suffer from some reduced international trade but that is as bad as it can get," says Joerg Radeke, an economist at the Center for Economics and Business Research in London. "But the data now has shown that none of the advanced economies is immune."

Unimpressive Stats

The EU's statistics office said on February 13 that the economy of the eurozone declined by 1.5 percent in the fourth quarter of last year. That is even worse than the 1 percent decline in the U.S. economy during the same period.

In the past two weeks, one of the best-known international ratings agencies, Standard & Poor's, has downgraded the credit ratings of three eurozone members, Greece, Spain, and Portugal.

That means those countries will have greater difficult attracting investment money when they issue government bonds. Bonds are one of the main instruments states have to fund stimulus packages to lift their economies out of recession.

The Greek government, for example, now has to offer 3 percentage points of interest more to attract buyers for its bonds than does Germany.

In Ireland things look even worse. Dublin is struggling to keep its budget deficit from nearing 12 percent of the country's Gross Domestic Product (GDP) by next year as the economy contracts. That has raised worries about whether the government can still afford to cover the massive debts of its banks if it has to.

Worries about oversized bank debts compared to GDP also extend to some other eurozone states. Those include Luxembourg, Belgium, the Netherlands, Austria, and Sweden.

Radeke says all these things are symptoms not only of recession but also of a major problem that the United States does not have. The eurozone's many national economises are in trouble for different reasons, and there is no single doctor, or strategy, for investors to put their trust in.

"The thing with the eurozone is that, unlike the U.S. or the U.K., there is not one reason why the economic performance is so bad but the reason differs from country to country. And therefore if is more challenging for policy makers to come up with the right action," Radeke says. "Take Spain, which has a very large exposure through the housing market and collapsing construction industry, Germany being particularly exposed to the global downturn due to its large export (sector), Eastern European countries which depend quite a bit on how their exchange rate is doing -- so, obviously a one-size-fits-all approach does not work very well."

Working Together?

About the only thing everyone can agree on is that letting states address their problems individually cannot work. The eurozone economies are simply too intertwined by cross-border banking and trade for an action in one not to affect another.

For that reason, EU officials talk of forging coordinated responses. But Radeke says that, so far, their public statements are more coordinated than their action plans.

"They made, early on, a [coordinated] approach by passing a common eurozone fiscal stimulus package; but looking closer at it, it turned out to be just the sum of the national measures," Radeke says. "But at least there was some attempt to coordinate measures."

One reason for the modest progress toward a truly coordinated response is that the Maastricht treaty prohibits eurozone bailouts by EU bodies, though it does allow for aid to countries facing "exceptional occurrences beyond its control."

Another reason is the reluctance of Germany, the eurozone's biggest economy, to fund what would likely be the majority share of the bail-out burden.

Still, there are signs that the eurozone is steadily realizing it is running out of time for caution.

German Finance Minister Peer Steinbruck said on February 17 that "the euro-region treaties don't foresee any help for insolvent states, but in reality the others would have to rescue those running into difficulty."

At first glace, that might seem like the start of a generous change of heart. But Germany also knows that, as the eurozone's biggest exporter, it would also suffer if its eurzone trading partners become too weak.

The question now is whether such feelings of selflessness combined with self-interest can sweep through the eurozone as quickly as have the economic storms. Until they do, there may be little to stop the value of euro -- the barometer of the eurozone -- from falling further.
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