How the weak dollar could demolish the eurozone

A dollar will now buy less than 50p in Britain - bad news for US travellers. But it's not just Americans who should fear the weak dollar - it could also spell trouble for the eurozone…

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It's rarely been more expensive to be an American abroad.

A dollar will now buy you less than 50p in Britain, and it's at an all-time low in the eurozone.

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That's certainly bad news for Americans who are traveling, and for those poor benighted UK-based American investment bankers whose bonuses apparently are calculated in dollars. As Hamish McRae put it in the Independent on Sunday, the poor dears'.

But it's not just itinerant Americans who should fear the weak dollar

The big economic question at the moment is this: can the rest of the world keep merrily growing if America goes into recession and has to retire from the field for a while?

The answer to many, seems yes: a desire to believe wholeheartedly in the decoupling' story is what's driving emerging markets to their recent highs. The global growth' story is seen as the driver for the next big bubble, and people are desperate to jump on the bandwagon before the gains peter out.

However, others are less convinced that this happy scenario can come to pass. As Morgan Stanley's Stephen Roach points out: "The American consumer has been the dominant engine on the demand side of the global economy for the past 11 years," accounting for 19% of world GDP.

But now jobs growth is slowing, house prices are falling and only set to get worse Roach expects declines in both 2008 and 2009. With people unable to rely on their properties to fund their spending anymore, and in fear for their jobs, even the legendary US consumer is going to find it harder to keep up their shopping habits in the near future. "I don't see any way that saving-short, overly-indebted American consumers can maintain excessive consumption growth," as Roach puts it.

That suggests a "high and rising recession risk" for America. "Unfortunately the same prognosis is likely for a still US-centric global economy."

Roach points out that developing Asia relies extremely heavily on exports in the past 25 years, exports have grown from accounting for less than 20% of the economy in 1980 to more than 45% today. Meanwhile, domestic consumption has sank from 67% to less than 50% at the same time. Given that a fifth of Chinese exports go to America, a recession there is clearly going to be problematic.

The falling dollar just makes all of this worse. A falling dollar means imports from other countries become more expensive for American consumers. If the price of goods is rising, even as their house prices and job security are in decline, then Americans will be under even more pressure to stop buying.

It's not just Asia that will feel the pain from this. It's Europe too in fact, if anything, the eurozone will suffer more. As Liam Halligan points out in The Sunday Telegraph, "recent events in the world's financial markets have given Europe a serious jolt." The region is now expected to see growth slow sharply, from 3.1% last year, to 2% this year. "The main reason is that Europe is also export-driven."

As Halligan points out "until recently eurozone exports were growing at an annual rate of 10%. By the end of this year, that rate may not even be 5% - a fall that will spook European consumers and businesses, undermining the continental economies."

It's much worse for Europe, because the euro is a free-floating currency (most Asian and Gulf State currencies basically track the dollar through official or unofficial dollar pegs). That means that so far it has borne the brunt of the dollar collapse. If the Federal Reserve cuts rates again this week which is a distinct possibility European exporters will be even more miserable.

As one Italian exporter comments to Ambrose Evans-Pritchard in The Telegraph: "The euro has risen 60% against the dollar since 2001. Until now companies have held share by squeezing margins but it's no longer possible at this level. A strong currency is one thing. It is quite another when the exchange rate completely decouples from the real economy."

But with German inflation hitting 2.7% in September, the chances of the European Central Bank relieving the pain with a rate cut any time soon is highly unlikely. This can only contribute to political instability in the eurozone.

Of course, in the meantime, as the eurozone bears the brunt of the pain, Asia may well continue to prosper in the short term. So it's no surprise that people are continuing to pile into the region and the best may be yet to come. You can find out more about the best way to play the global growth bubble' in the current issue of MoneyWeek. If you're not already a subscriber, then why not sign up for a three-week free trial?

Turning to the wider markets

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In London, stocks headed higher, helped by an upbeat outlook from US mortgage giant Countrywide Financial, which said it hopes to be profitable again this quarter. DIY group Kingfisher was the top riser on vague bid rumours. The blue-chip FTSE 100 index rose 85 points to 6,661. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 gained 34 points to end the day at 5,794, whilst the Frankfurt DAX-30 was 16 points higher, at 7,949.

On Wall Street, stocks ended higher, with a strong quarterly profit report from Microsoft helping the technology sector in particular. Improved forecasts from Countrywide Financial also helped sentiment. The Dow Jones ended the day 134 points higher at 13,806. The tech-rich Nasdaq gained 53 points to close at 2,804, while the S&P 500 was up 20 points, at 1,535.

In Asia, stocks were higher. Japan's benchmark Nikkei 225 rose 192 points to 16,698. Retail sales in the country rose in September for the second month in a row. Meanwhile Hong Kong's Hang Seng breached the 31,000 mark for the first time.

Crude oil hit a fresh record, heading above $93 a barrel as Mexico shut down a fifth of production, and the dollar weakened further. In New York this morning it was trading at $92.71 a barrel, while Brent spot was at $89.28.

Spot gold was on the up again this morning, last trading at $792. And silver was also higher, at $14.40.

Turning to the forex markets, sterling was trading at 2.0568 against the dollar, and 1.4269 against the euro. The dollar was at 114.24 against the Japanese yen, and 0.6940 against the euro.

And in London this morning, the Bank of England reports that the number of new mortgage approvals fell from 108,000 to 102,000 in September, the lowest in just over two years. Meanwhile, data from Hometrack suggests that annual house price inflation in England and Wales fell to 4.4% in October (from 5% in September) the lowest since September 2006 while the number of potential buyers registering with estate agents fell 6.4% in the month, the biggest fall seen since the survey started in 2001.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.