During the next few years, American pump manufacturers will face several challenges in their dealings with the eurozone. The first challenge relates to exchange rates, and the second relates to the viability of the eurozone—and European Union (EU) as a whole—as an economic bloc.
The first issue facing the U.S. pump industry is that the dollar is expected to increase in value. For some time, the Federal Reserve had signaled that it was going to end its program of monetary expansion, also known as quantitative easing. In the last few months, the Fed had been scaling back its monthly program of bond buying and announced the end of the program in late October. This has led to an increase in interest rates. The 10-year Treasury rate rose from 1.663 percent in April 2014 to about 2.32 percent by late November 2014. While this may not seem like much, the dollar has strengthened by 7.25 percent against the euro during roughly the same period.
In addition, the European Central Bank is cutting interest rates in an attempt to create a weaker euro to spur exports. Having institutions on both sides of the Atlantic pushing policies that will result in a stronger dollar and a weaker euro creates a virtual certainty that this is what will occur during the next few years.
Some economies in Western Europe—such as Switzerland, Denmark, Sweden and the U.K.—do not use the euro. However, the economies of these countries all rely heavily on exports into the eurozone. Therefore, the central reserve banks will likely act to prevent their currencies from becoming too strong in relation to the euro, as Switzerland’s bank did in 2011 and 2012. Whatever happens to the strength of the euro will generally be reflected in the other European currencies.
EU Internal Strife
The second issue is what will happen if one or more of the eurozone countries experiences a crisis. The European integration project has been a top-down initiative. In other words, this project has been pushed along by the leadership without necessarily allowing for natural economic integration. Experts say this particular strategy to create a large, integrated, dynamic economy cannot be sustained in the long-term.
The European political leadership has shown difficulty with reform and an aversion to enforcing politically painful policies. For example, in 2005 the EU did not remove Greece from the eurozone when it was discovered that the country altered the deficit numbers to meet the criteria to be allowed into the coalition. While the financial markets have essentially forced economic reforms on Greece and other countries, the reforms may not be sufficient. Some question the extent to which they will actually be implemented, because of possible institutional resistance. The urgency to embrace reform seems to be lacking.
When the next crisis occurs, the institutional structures of the EU will be prone to do everything in their power, such as interest rate adjustments, debt restructuring and economic reforms, to keep a country in the eurozone. However, these reforms are not likely to solve the long-term structural economic problems in these countries and will only calm the financial markets temporarily.
The internal conflicts between different economies and cultures within the EU mean that devolutionary tendencies and resentments will probably always exist. Countries in financial crisis will resent being instructed by other EU countries, and those not in crisis will resent paying for those who are. Simply put, some countries should be allowed to leave the EU, or even forced to do so. Looking at the long-term forecast, the next five to 10 years may bring periodic financial crisis, followed by periodic bailouts, attempts at reform and eventually several countries leaving the eurozone.
Any crisis in the eurozone will equate to a weaker euro in relation to the dollar. This means that products produced in the rest of the world and exported into Europe will be relatively more expensive in relation to products produced there. Furthermore, a eurozone crisis could lead to a general European economic weakening, which would also reduce the ability of Europeans to purchase imports. Those firms who produce in the U.S. or Asia for export to Europe would be adversely affected.
Conversely, those firms who produce in Europe and export into the U.S. or other parts of the world could see a benefit to some degree. For the portion of the pump industry that tends to be a commodity business, the eurozone could be a difficult sales environment, and margins would be squeezed for products exported there. Specialty pumps would face similar, though less severe, conditions.