Just a few months ago, there was a strong belief among many currency strategists that the European economy would pick up during the second half of the year, that Europe would get a handle on its debt crisis and that the euro would deliver a lot of value. So far, those forecasts have not been borne out. The price of the euro, currently $1.35, remains above its 12-year average of $1.2024, and it has increased 15 percent against the dollar over the past year thanks to Washington’s fiscal mess and political stalemate. But as Europe’s fiscal crisis accelerated and its economy slowed, the euro declined 6 percent during a nine-day period that ended September 21.
“This surprised many commentators,” says Ken Dickson, investment director for money markets and foreign exchange at Standard Life Investments. In an interview with Institutional Investor contributor Steve Rosenbush, Dickson asserts that they shouldn’t have been surprised. What follows is an edited version of their conversation.
Institutional Investor: Some strategists have argued that sooner or later Europe will get its debt crisis under control and that the political resolution of that dilemma will unlock value in the euro. Do you agree?
Dickson: There is no shortcut to resolving the problems in Europe. Therefore it is hard to see the euro gaining strength for any long-lasting periods for the next couple of years or so. We think the euro will be weak in the near term and generally pretty weak for the next few years.
In the aftermath of the crisis of 2008, the underlying question facing Europe was whether it faced a liquidity problem or recapitalization problems. The European Central Bank concluded that the problems in Europe were largely a matter of liquidity, and the solutions to the crisis were largely liquidity solutions. Now it looks like those problems are a matter of high indebtedness, very low growth and a need for substantial recapitalization. That is why the outlook for Europe and the euro has changed relative to other countries, particularly the U.S.
The U.S. suffers from slow economic growth, fiscal problems and political stalemate. Why would its outlook be any better than that of Europe?
The implementation of fiscal programs in the U.S. involves a good deal of political debate. But the debate has shifted in the U.S. It was previously about spending its way out of recession through looser fiscal policies. Now it has moved on to solutions that involve more-responsible, longer-term fiscal planning. Now the debate in the U.S. is on how it is best to achieve those spending reforms, through more spending cuts or through higher taxes.
The U.S. has a bit more time to organize and agree on fiscal consolidation. I think that the U.S. will continue to edge toward the right solutions, although it won’t be a dramatic move and it won’t occur until after the presidential election.
How do you think the European debt crisis will be addressed, and what does that mean for the euro?
We think that the outlook for growth in Euroland and for the euro will be very grim for a number of years. In the periphery growth can move toward the zero bound. As a whole, Europe has always grown more slowly than the U.S., and it is likely to fall behind during the next few years.
The euro zone is likely to stay together, though. But the costs of breaking up, or coming closer together in a fuller fiscal union, look pretty horrendous. The legal framework for fiscal union is just not that obvious.
The most likely event, as we move toward a solution for Europe’s debt crisis, is that quantitative easing will drive the euro lower. And we think the schedule of payments for Greece will continue.
Will quantitative easing be any more effective in Europe than it has been in the U.S.?
We think the impact of quantitative easing on Europe’s economy will be pretty muted, especially because the undercapitalization of financial institutions makes it difficult to transmit money into the economy. We doubt how effective the transmission mechanism can be until the underlying problems of the sovereign debt crisis are really solved.
Given your outlook for a weak euro, are there any currencies that present a better value?
In the very near term, the U.S. dollar will benefit as the preferred safe-haven currency. And we still like the Norwegian krone. It is not big enough to be a safe haven, but it has elements of being a safe haven. We are still concerned that high-beta currencies will weaken some. We have concerns about the Australian dollar and the New Zealand dollar. Sterling is still attractive, at least on a trade-weighted basis.
