During the last year in the Eurozone, one of the most headline-capturing issues was the threat that Greece would be forced out of the common currency. Although a third bailout package has dampened this crisis for the time being, the danger has not been eliminated. This is primarily because institutional resistance to enacting reforms demanded by international creditors, coupled with a sclerotic Greek economy, could mean that it is only a matter of time before Greece faces another potential exit—with all of the euro-weakening instability that will result.
In addition, other countries—most recently Portugal, whose ruling party was ousted by an anti-austerity coalition, thereby calling into question its commitment to economic reforms—have the potential to face similar challenges as Greece. Even Spain and Italy are at risk. Although Spain has undergone a period of reform and deflation within the Eurozone, which is making it internationally competitive again, continued high unemployment may undermine the political legitimacy of the government and lead either this government, or a new one, to abandon reforms. Italy, on the other hand, seems to have stabilized, but a stagnant economy coupled with a large public debt could cause the nation to fall back into a crisis.
These governments have evolved over time to have well-organized vested interests wanting to protect the status quo. They typically oppose reforms that could open up their economies, making them more flexible and more likely to sustain growth. These economies were structured at a time when the global economic landscape looked significantly different than it does today. They are finding that they lack the flexibility to compete globally.
These fragile economies—and the European Central Bank's (ECB) attempt to increase their competitiveness through either monetary easing or lack of monetary tightening—will continue to contribute to a weaker euro for the foreseeable future. The impact of the ECB's actions over the last couple of years can be seen in Table 1.
Over this time, the price of 1 euro in dollars has declined from $1.35 per euro in October 2013 to $1.10 per euro in the beginning of November 2015. This phenomenon is likely to increase the challenges for U.S. pump manufacturers that export to the Eurozone, as the ECB shows no signs of reversing course in the foreseeable future.
In addition to a weaker euro, the pump industry must consider other factors that contribute to overall dollar strength. One factor is the economic deterioration of emerging economies such as China. Some data indicates that China may be coming to the end of a large economic bubble fueled by bad lending. Stories of large tracts of real estate—even entire cities—sitting empty waiting for buyers foreshadow a possible financial crash that could dwarf the economic downturn experienced by the U.S. This problem, coupled with the fact that China is no longer an economy the world can ignore, makes an economic crisis a distinct possibility. Even countries such as Brazil that only a few years ago were hailed as the next big economies to develop are finding that lower prices for primary products, underdeveloped public institutions and politically connected vested interests are not allowing them to achieve their economic potential. Economic weakness in these countries is likely to keep the dollar strong as investors continue to see the dollar as a safe-haven currency.
The second major factor contributing to dollar strength is that the U.S. Federal Reserve is looking to raise interest rates as the U.S. economy continues to recover. At press time, no decision has been made, but the Federal Reserve is likely to raise rates in 2016. This action, when it comes, will increase the rate of return on dollar-denominated assets, leading to a stronger dollar and providing a headwind for any U.S. companies looking to export.
Finally, increasing geopolitical instability over the last few years—including Russia in the Ukraine, the civil war in Syria, Chinese aggression in the South China Seas, the Iranian nuclear program and the rise of the Islamic State in Iraq and Syria (ISIS)—is creating a world with fewer safe havens. The appreciation of real estate in certain American metropolitan areas is being driven, in part, by foreign money moving in and buying property. Despite some of the challenges and problems of the U.S. political system, America is still seen as a safe harbor for funds in a world that is becoming increasingly unstable. This factor will continue to support dollar strength.
Many factors are contributing to the increase in the strength of the dollar relative to the euro. Combined, these factors virtually guarantee that the era of the weakening dollar that lasted from 2000 to 2014 is likely over for the foreseeable future.
Going forward, U.S. pump manufacturers can expect to find a more challenging export environment, not just to the European Union but to other regions as well. These challenges could be greater than any experienced over the first decade and a half of the new millennium.