Peter Bofinger is a professor of economics at the University of Würzburg and was a member of the Advisory Council.
Since May 2021, the euro has lost almost a fifth of its value against the US dollar. You now get less than a dollar for one euro. The price loss is increasingly being interpreted as a sign of political and economic weakness in the euro area. Therefore stronger integration steps are in particular, a stronger communal financial policy is necessary, not least a system to cushion geopolitical and economic shocks.
But is the euro’s weak dollar really a cause for concern? A look at the past shows a pronounced up and down. The previous low was reached on October 26, 2000 with 0.8252 dollars for one euro. On July 15, 2008, the price had almost doubled at 1.599 with little fundamental change.
An important role for the ups and downs plays the difference between the short-term interest rates for euro and dollar investments. As a rule of thumb, if euro interest rates are higher than dollar interest rates, the euro is strong and vice versa. With the dollar’s current yield advantage, it’s not surprising that the euro is depreciating.
The explanation for this is the trading strategy of the “carry trade”: a market participant borrows for a short time in the currency with the low interest rate and invests the funds in the currency with the high interest rate.
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If many market participants behave in this way, the dollar appreciates and, in addition to the interest rate advantage, there is also a price gain. Since the interest rate advantage of the dollar will not change for the time being, one should be prepared for a further depreciation of the euro against the dollar.
The euro’s low dollar exchange rate should therefore not be interpreted as a symptom of problems in the euro area. In any case, this is more a matter of dollar strength than euro weakness. Since May 2021, the euro has depreciated by only around six percent against a basket of currencies from the most important trading partners in the euro area, which is 13 percent above its starting level in January 1999. It is therefore anything but a weak currency.
>> Read here: Is the dollar about to crash?
But it is also advisable, independently of the euro, to think about more integration in the euro area. A common strategy is now urgently needed to promote renewable energies, create integrated energy grids and increase energy efficiency. This requires extensive state funds to promote private investment.
Many member states will not be able to do this after the expenditures for fighting the corona pandemic and the consequences of the Ukraine war. A common fund based on the model of “Next Generation EU” would therefore be the method of choice. With an EU tax on energy sources, the repayment could be financed in the coming decades and an additional incentive to save energy could be created.
More: Europe must jointly assume responsibility for the euro – but to do so it must change course.