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Euro Becomes Stronger

July 8, 2010

A month ago today, the euro fell to €1 = $1.19, which was the lowest it had been in five years.  Newspapers started writing how the euro may continue to fall and even its possible demise.  As a result, I thought that the euro would continue to devalue.  However, imagine my surprise today when I check out the exchange rate before my trip to Europe, only to learn that the euro was now trading at $1.27.  For a traveler on a shoestring budget, even this small change will affect me, since €100 will now cost $8 more than even a month ago.  Yes, I am happy that the euro is nowhere near its record of €1 = $1.57, but it is still surprising that the euro has risen 8% in a month.

As the Figure 1 demonstrates, after the euro reached its recent low on June 8, it has been slowly increasing, to the point that it is now trading at the same value as it had been around May 12th.  On May 11th, the EU had just announced its €750 billion rescue plan for Greece and other countries, and the euro plummeted.  Since the Greek Parliament approved a pension reform plan today as part of its austerity measures and strikes griped the country as a result, economic tensions definitely remain in the Eurozone.  So why is the euro on the rebound?

Quick searches of my favorite news organizations (the BBC, The New York Times, and The Economist) does not reveal an answer.   NPR actually reported to opposite on Tuesday, stating everyone seems to want to hold dollars instead of other currencies.  With demand for dollars increasing relative to the euro, the “price” of dollars also increases.  Instead of Figure 1, imagine the inverse, which would show a steady increase in the value of the dollar until recently.  For instance, now $1 will costs €0.79, but at the beginning of the year, it cost around €0.68.

This makes me wonder if this is just a small jump that only makes the timing of my trip slightly unfortunate, and perhaps there is not an underlying reason for the recent strengthening euro.  However, if you look at the European Central Banks website graphing the exchange rate since 1999, this upswing is rather long.  While international exchange markets are notoriously unpredictable, I will suggest one possible explanation:  the current U.S. and the European approaches to the global financial crisis.

As I wrote on Tuesday in “The Move towards Austerity in Europe,” the BBC reported that governments in 25 of the 27 EU member states (including all but one member of the Eurozone) had started to cut their budgets.  At the same time, talk remains in the U.S. of a second stimulus package and President Obama had urged world leaders to not cut government spending too quickly.  So perhaps the international currency traders are actually now “rewarding” the Eurozone for its austerity actions.

If the U.S. continues to its large deficit spending while Europe continues to cut back, the dollar may continue to weaken as the supply of dollars will increase relative to other currencies.  The European Central Bank has already announced that it will offset any bond purchases to keep them “inflation neutral,” meaning that a sudden surge in the supply of euros probably will not occur.

As a result, perhaps I was too optimistic that I would be reaping the benefits of €1 = $1.10 when traveling in Europe, and may have to continue to accepting that fact that prices will remain high for the American tourist traveling in the Eurozone.

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