U.S. Dollar's Slide Could Push
Europe Closer to a Recession

The Bush administration's retreat from a long-standing "strong-dollar" policy sent the U.S. currency skidding nearly to its lowest level yet against the euro and set in motion forces that could drive Europe's already-beleaguered economy closer to recession.

The 12 countries in the euro zone, whose collective economy is second only to that of the U.S., have muddled through the downturn of the past two years with help from a weak euro that boosted exports. But that economic prop has been rapidly disappearing. The euro's newfound strength makes those exports more expensive for buyers abroad. It also makes profits European companies earn in dollar-based economies overseas worth relatively less when brought back to Europe.

THE DOLLAR'S STUMBLE • Dollar's Fall May Boost U.S. Companies1   • Dollar Inflates Tech Industry's Gains2   • A Painful Message for Japan's Yen3   • Europe Companies Are Quick to Blame4   • Stocks Fall on Snow Comments5   • Page One: Snow Redefines 'Strong'6 05/19/03

Deepening troubles in Europe present more bad news for the world economy, which is facing pressures on several other fronts. There is slower-than-expected growth in the U.S., deflation in Japan and the economic impact of the SARS outbreak in Asia.

"There is now a very distinct risk of a Europe-wide recession this summer," said Robert Lind, European economist with ABN Amro in London. A stronger euro has arrived at "precisely the wrong time," he added. A recession is typically defined as two successive quarters of economic contraction.

The euro's latest surge -- the currency has risen 27% against the dollar in the past year -- came after U.S. Treasury Secretary John Snow seemed to redefine the U.S. strong-dollar policy at a meeting of the Group of Eight major industrial countries over the weekend. Rather than intending the phrase -- a staple of U.S. economic policy for years -- to mean the U.S. wants a strong dollar versus other currencies, Mr. Snow said it meant a robust currency that people would want to use for commerce and couldn't be easily counterfeited.

The apparent U.S. shift drove the euro as high as $1.1738 in intraday trading Monday -- above its $1.1680 value when the currency was officially born on Jan. 1, 1999, though still a hair's breadth below the level of $1.1750 on the first day the euro actually traded three days later. Profit-taking reduced some of the euro's gains, and it was quoted late in New York Monday at $1.1663, up from $1.1574 on Friday. Around midday in Tokyo Tuesday, the euro was quoted at $1.1656.

The year is shaping up as the worst for the euro-zone economy since the recession a decade ago. After Eurostat, the European economic-statistics agency, reported last week that the economy didn't grow at all in the first quarter, economists started ratcheting down growth forecasts for 2003 to 1% or lower.

Wim Duisenberg, president of the European Central Bank, told reporters after a speech in Zurich that the euro's strength "does undermine somewhat our competitive position in world markets," though he added it also has boosted the purchasing power of Europeans.

The euro's strength is an economic drag, much as higher interest rates would be during a downturn. The euro's gains since November have been the equivalent of an interest-rate increase of nearly two percentage points, Merrill Lynch & Co. estimates, more than enough to offset the 0.75-percentage-point easing the European Central Bank made during that time. At a time when many economists and policymakers feel the ECB hasn't trimmed rates enough to reverse Europe's sluggishness, the euro's rise has meant that the economy is facing stiffer headwinds now than six months ago.

How badly Europe is ultimately affected by the euro's rise depends a great deal on how soon the expected U.S. growth spurred by the weak dollar might rub off on Europe. Exports by U.S. companies could climb as their goods become cheaper when priced in euros or yen. But the dollar decline could backfire if it falls too far and too fast, frightening foreign investors away from U.S. equity markets. A recession in Europe also could hurt the U.S. by shrinking demand for American goods and services.

The benefit to the global economy of any economic recovery in the U.S. would be large, but might not help European companies any time soon. Already hampered by higher costs at home -- due to higher tax rates, social benefits and wages -- the euro's rise means many European companies are at an even-greater disadvantage when competing against American counterparts who are reaping the rewards of a weaker currency.

"The U.S. emerges as a net beneficiary from this process and the other economies are net losers," said John Llewellyn, chief global economist for Lehman Brothers and a former official at the Organization for Economic Cooperation and Development.

The Bush administration moved Monday to limit the damage to the dollar from Mr. Snow's remarks, but it didn't suggest that it would try to bolster the currency. "There is no change involved in the dollar," White House spokesman Ari Fleischer said. "The government supports a strong dollar." A Treasury spokesman echoed those remarks. But Mr. Fleischer wouldn't define what he meant by a strong dollar. "I am not in the business of defining technical financial matters," he said. "That is not what the White House speaks of."

Richard Clarida, who resigned last week as the Treasury's top economist, said the Bush dollar strategy eschews sales and purchases of dollars to influence its value. "We have indicated that intervention is not something frequently deployed," he said. Recently the Federal Reserve has said it would try to head off deflation through low interest rates, a policy which would tend to make the dollar weaker. Mr. Clarida, who is now at New York's Columbia University, said he doubted the Bush administration would try to stand in the way of the Fed's monetary goals either by intervening in currency markets or trying to jawbone the Fed to reverse course.

European corporate financial results are already showing the impact of a stronger euro. Dutch retailer Ahold NV, the world's third-largest supermarket group, which is in the midst of an accounting scandal, generates 78% of its sales in the U.S. through major supermarket chains such as Stop & Shop and Giant. Last week it reported first-quarter sales when converted to euros slid 11%. But when currency effects were stripped out, sales actually grew by 4.6%. Other well-known names from Philips Electronics NV to Heineken NV also have seen sales hurt by the strengthening euro.

Some companies, such as European Aeronautic Defense & Space Co., the parent of Airbus and one of the world's largest aerospace companies, have managed to hedge against the euro's rise. But for other companies it is making an already difficult business climate worse.

Karlheinz Hoemier, chief financial officer at A&F Automation & Conveyor Technology Ltd., a packaging company based in Kirchlengern, Germany, says the stronger euro will put pressure on its market share in the U.S., where the company has revenue of about €2 million ($2.3 million) a year. "At the moment we don't have any solutions," he said. "What can we do?"

Pernod Ricard SA, the French spirits group, 18 months ago greatly increased its dollar exposure when it bought a part of the U.S.-based Seagram's liquor portfolio. Now, about a quarter of its sales are earned in the U.S. As a result, every time the euro strengthens 10 U.S. cents, it costs the company €22 million in lower revenue. The company doesn't hedge so "we just have to live with it," said Richard Burrows, Pernod's co-managing director.

Dutch brewer Heineken said dollar weakness could dent its future U.S. profits. Because manufacturing costs are calculated in euros, a weak dollar can hit the bottom line when sales in the U.S. are converted from dollars to euros. Anthony Ruys, Heineken's chief executive, said the company had hedged against the dollar's fall in 2003. But he predicted the dollar's weakness could shave as much as €50 million from profits in 2004.

Philips, Europe's biggest consumer-electronics company, said sales in the first quarter fell 14% when converted to euros. Without the difference in the exchange rate, it said sales would have improved by 1%. But Mark Kirkland, global head of financial risk services, said Philips's bottom line wasn't much affected because the company had hedged against the currency risk.

When the dollar began to slide against the euro last year, Clemente Gonzalez Soler, CEO of Grupo Aliberico SA, Spain's largest producer of semitransformed aluminum, which is traded in dollars, thought his company was safe from exchange-rate turmoil. But he soon realized that many of his costs were in euros, which could give a leg up in the European market to lower-cost producers from India and Latin America, where costs are predominantly dollar-based.

"In theory, because aluminum trades in dollars, we shouldn't have had problems," said Mr. Gonzalez Soler. "But that's just not the case."

The euro's strength isn't universally perceived as bad news for Europe. For one, a stronger euro makes imports less expensive, which can ease inflationary pressures. Another bright spot: Europe imports the bulk of its oil, which is priced in dollars. A stronger euro effectively lowers the Continent's energy costs.

Write to Christopher Rhoads at christopher.rhoads@wsj.com⁷ and Michael R. Sesit at michael.sesit@wsj.com⁸

Updated May 20, 2003 7:53 a.m.