The Euro’s Fall from Grace
By IBISWorld Analysts Brian Bueno & Nikoleta Panteva
With fears about sovereign debt defaults looming, European economies in recession, and continued policy disagreements across the region, the fate of the euro has been called into question. The yield on Spain’s 10-year bonds has been on the rise, increasing fears of potential default and spreading concerns about the debt of other countries, such as Italy.
The uncertainty surrounding the financial future of European sovereign debt has appreciated the value of the dollar relative to the euro, and wary investors have moved away from risky assets and toward safer US assets. Over June 2012 and through mid-July, the euro has consistently traded below $1.27, compared to an average of $1.40 in 2011, signifying the dollar’s appreciation against the euro. In fact, the euro has fallen more than 21.0% from its 2008 peak, as the region’s crisis pushed European economies into recession. Borrowing costs for heavily indebted nations have subsequently increased, forcing Greece, Ireland, Portugal and Spain to seek bailouts.
The financial stability of the eurozone will be a determining factor in the relative exchange rate of the dollar and the euro. Further financial turmoil in the region could send the euro crashing relative to the dollar. Beyond the overall economic implications of such a turn of events, an appreciating US dollar could wreak havoc on US industries that are heavily dependent on or threatened by trade with Europe. As the dollar has strengthened against the euro, the trade deficit between the two economic powerhouses has increased, hurting the relative trade strength of the United States. As the dollar gains value, American-made goods become more costly to foreign buyers. For instance, as the strength of the euro decreased 4.6% in 2010 from $1.39 to $1.32, the trade deficit surged 27.9% to $93.3 billion. This means the United States imported $93.3 billion more than it exported to its 15 largest EU trading partners (the EU15) in 2010. From 2004 to 2012, the trade deficit between the United States and the EU15 has moved largely in line with the euro and dollar exchange rate.
IBISWorld has analyzed the potential for further appreciation of the dollar against the euro and the scenario’s effects on various US industries. Industries that heavily depend on exports to Europe will be negatively affected because US-made goods become more expensive and less attractive for purchase within eurozone markets. For example, the US Coal Mining industry (IBISWorld report 21211) generates a significant 13.7% of its annual revenue from EU15 markets. Conversely, rising imports from EU countries will limit the growth of some US industries already facing high import competition from Europe. There are also US industries that engage heavily in both imports from and exports to Europe, making these industries particularly vulnerable to further euro value erosion. For instance, the US Car and Automobile Manufacturing industry competes against European-made automobiles within the US market while simultaneously depending on European demand for American cars.
The global financial crisis in the second half 2008 and the resultant recession caused the EU’s economy to shrink 3.1% in 2008 and 6.5% in 2009, the largest single-year change since the union’s inception. As a result, Germany contracted 3.4%, France by 2.2% and Italy by 3.8% in 2009, because they are heavily dependent on trade, especially with the United States, Russia and China, which were all strongly hit by the recession. Meanwhile, in the United Kingdom, whose banking sector dominates its economy, the global financial crisis wreaked havoc and contracted its GDP 15.7% in 2009. These four economies accounted for a loss of €437.6 billion in production in 2009. As the leading economies shrank, intra-union spending and trade fell, causing the economies of each member to contract in 2009. In addition, the financial crisis sparked major debt problems in Ireland, Portugal and Greece, impeding the recovery of other member nations.
Despite bailout loans and EU-imposed austerity plans for Greece, fears remain about default spreading to other EU nations, particularly Spain. Greece was headed toward default in 2011, after having its bonds downgraded to junk status, but the other members approved an economic plan to aid in an “orderly default.” In February 2012, Greece received a second bailout package worth €130.0 billion that was conditional on the implementation of further austerity measures and included a debt restructuring agreement. Political conditions in the country during its recent legislative elections, however, sparked renewed fears about Greece’s exit from the eurozone and the potential collapse of the euro currency altogether.
Facing large deficits and public debt, austerity measures in Spain since 2010 assisted in trimming the country’s deficit, but further weakened its economy. In 2012, Spanish banks received a series of credit rating downgrades, culminating in a €100.0-billion bailout loan from eurozone countries to help its ailing banking sector. Fears about the banks or the Spanish government defaulting on the EU bailout loan have fueled more investor uncertainty. These concerns have kept Spain’s benchmark 10-year borrowing rate above 6.0%, and has spread further concern upon the financial stability of other eurozone members, such as Italy.
Export losers
An appreciation of the US dollar against the euro makes US goods more expensive in European markets. The United States is expected to export $236.8 billion in goods to EU15 countries in 2012; however, this number could decline drastically if ailing European economies continue their freefall or if the relative value of the euro declines precipitously. Some of the industries most affected by the potential decline in export demand include copper, zinc and lead refining; coal mining; plastic and resin manufacturing; and computer and peripherals manufacturing.
One of the biggest losers of export revenue if the dollar were to drastically appreciate against the euro would be the Copper, Zinc and Lead Refining industry (IBISWorld report 33141), which comprises firms that produce nonferrous metal products (i.e. metals other than iron and steel). In 2012, the total export value of nonferrous metal products to the EU15 is projected to reach $15.6 billion, accounting for about 6.6% of all exports to EU15 countries. Moreover, these exports are expected to account for 56.5% of total industry exports. Industry giant Freeport-McMoRan Copper and Gold generates about 65.0% of its revenue from non-US customers. Therefore, a substantial appreciation in US dollar value can have a particularly negative impact on company revenue because major European customers would face higher prices for industry goods.
The US Coal Mining industry generates about 31.3% of its revenue from coal exports. In 2012, it is expected to export coal worth an estimated $16.3 billion. Of this total, 43.9%, or $7.2-billion worth of raw coal, will be destined for EU15 countries. According to the US Energy Information Administration, the Netherlands and United Kingdom ranked in the top 10 destinations for both US metallurgical coal exports (i.e. coal used in steel production) and steam coal exports (i.e. coal used in electricity generation). Other top 10 destinations for steam coal include Germany, France and Belgium, while Italy and Ukraine ranked among the top 10 US metallurgical coal destinations. European electricity generators increased demand for coal over 2011 in response to rising natural gas prices that increased the attractiveness of coal use. However, if US coal becomes prohibitively expensive due to exchange rate fluctuations, European markets may switch to sourcing coal from major competing coal producers in nations such as China, India, Australia and Russia. Moreover, weak European economies could trigger declining electricity demand, hurting overall demand for energy commodities, regardless of geographic source.
Firms in the Plastic and Resin Manufacturing industry (32521) also rely on European demand. Plastic and resin manufacturers sell products to downstream manufacturers of automobiles, electronics, home furnishings and a range of plastic goods, including many goods used for construction purposes. A potential increase in the US dollar value against the euro could force major automotive manufacturers in Germany to source inputs from other suppliers. Plastic and resin exports to EU15 nations are forecast to total $4.8 billion in 2012, representing a decline of about 4.6% since 2011, because recessionary conditions in Europe have already hurt demand from downstream manufacturing and construction markets. About 2.0% of the value of all US exports to EU15 countries will be made up of plastic and resin products.
The manufacture of computers and computer equipment has not all been offshored to China. Exports of US-made servers, computers and peripherals are expected to total $21.7 billion in 2012, of which 21.8%, or $4.7 billion, will be destined for EU15 countries. Customers in these countries purchase advanced computer products and services from major companies such as Hewlett- Packard and IBM. However, customers have increasingly sourced products from manufacturing facilities located in countries such as China. Therefore, the total value of computers and equipment exports from the United States to the EU15 has declined for more than a decade, from $15.1 billion in 2000. This decline could accelerate if the cost of purchasing products from US-based manufacturers increases due to changes in the US dollar and euro exchange rate.
Increased import competition
In general, a depreciation of the euro against the US dollar will make European-made goods less expensive on the US market. While an influx of lower-cost inputs may bode well for some industries, domestic manufacturers will experience heightened import competition. Some of the industries most affected by the potential increase in external competition include iron and steel manufacturing, power tools and other general purpose machinery manufacturing, jewelry manufacturing, and metalworking machinery manufacturing. Together, these industries’ revenue is estimated to total $189.3 billion in 2012. Imports from EU15 countries satisfy 11.7% of their aggregate domestic demand.
Within the Iron and Steel Manufacturing industry (IBISWorld report 33111), imports satisfy 28.7% of the domestic demand. In 2012, the total value of imports is expected to be $46.8 billion, of which $8.8 billion (or 18.9%) comes from the EU15. A drastic depreciation in the euro could push imports’ share of domestic demand up drastically, posing an external competitive threat to domestic iron and steel manufacturers. US-based industry players, including The Nucor Corporation, the United States Steel Corporation and the AK Steel Holding Corporation, could face falling revenue, a decrease in profit margins and even possible losses.
Imports account for a significant 70.3% of the Power Tools and Other General Purpose Machinery Manufacturing industry’s (33399) domestic demand. Total industry imports are estimated at $30.0 billion in 2012, and imports from EU15 countries are expected to make up 33.9% of that. While the industry is already saturated with imports, a depreciation of the Euro will intensify the already-strong external competition for domestic power tools manufacturers like Stanley Black & Decker.
Operators in the Jewelry Manufacturing industry (33991) face an interesting import scenario. Currently, imports account for 103.4% of the domestic demand for jewelry. Because imports are used and accounted for in several stages of the jewelry manufacturing process, their value is higher than the value of the final piece of jewelry piece. Still, imports provide a key component to jewelry manufacturing, and a sharp depreciation in the euro would increase imports’ presence in the domestic process. Imports from EU15 countries currently account for 17.1% of the $32.8-billion worth of imports; a rise in imports would significantly increase competition for domestic jewelers like major player Tiffany & Co.
The Metalworking Machinery Manufacturing industry (33351) – which produces power tools for finishing and shaping metal parts that are used in original equipment – is also set to suffer from a depreciated euro. Of the $18.9 billion in imports (which account for 42.4% of the industry’s domestic demand), 25.8% come from EU15 countries. As the euro becomes cheaper relative to the US dollar and other major trading partners’ currencies, European-made metalworking machinery will become less expensive, increasing in favor with US buyers. This will pose a competitive threat to US metalworking machinery manufacturers, including major player Kennametal Inc.
Some industries face double the trouble from a depreciating euro scenario. Operators in pharmaceutical manufacturing, turbine and engine manufacturing, semiconductor and electronic component manufacturing, and automobile manufacturing industries are in exceptionally risky situations. Together, these industries are expected to generate a total of $627.2 billion in revenue in 2012. These industries’ EU15-sourced imports satisfy a significant 46.1% of total domestic demand, while exports account for a substantial 26.2% of total revenue.
IBISWorld divides the pharmaceutical manufacturing sector into three individual industries: Brand Name Pharmaceutical Manufacturing (IBISWorld report 32541a), Generic Pharmaceutical Manufacturing (32541b) and Vitamin and Supplement Manufacturing (32541d). Each of these industries experiences high exposure to international trade. Brand name pharmaceutical producers are estimated to generate 29.9% of their revenue from export markets in 2012, and imports meet 44.3% of domestic demand. Operators in the Generic Pharmaceutical and in the Vitamin and Supplement Manufacturing industries face similarly high levels of export dependence and import competition. On the whole, these three industries combined generate 31.6% of their revenue from export markets, and imports meet 43.0% of domestic demand. Furthermore, exports headed to EU15 countries account for the lion’s share of total exports, at 53.0% in 2012; imports from EU15 countries account for an even larger 64.2% of total sector imports. Because so much of this sector is exposed to exchange rate fluctuations between the US dollar and the euro, depreciation in the latter would significantly impact overall business. Export markets would shrink as American-made pharmaceuticals become more expensive to European buyers. On the other hand, domestic manufacturers would suffer from the increased competition stemming from relatively cheaper imports. As such, industries in the pharmaceutical manufacturing sector have much to lose from a depreciating euro.
Similarly, companies in the Engine and Turbine Manufacturing industry (33361a) and the Wind Turbine Manufacturing industry (33361b) will suffer significantly if the eurozone’s sovereign debt crisis escalates. Engine and turbine manufacturers generate 60.2% of their revenue via exports and satisfy 58.1% of their domestic demand from imports. Wind turbine manufacturers have a similar breakdown. On the whole, exports for this sector account for 59.9% of joint revenue and imports make up 57.6% of domestic demand. Of the $26.7 billion in exports, those going to the EU15 zone account for 18.4%; of the $27.6 billion in imports, 33.4% are sourced from these countries. This double exposure could spell disaster for the two turbine industries as they lose competitiveness in their export markets and domestically.
Manufacturers of semiconductors and other electronic components also face a significant risk if the euro depreciates. Companies in the Semiconductor and Circuit Manufacturing industry (33441a), along with those in the Circuit Board and Electronic Component Manufacturing industry (33441b), are likely to be more affected by the influx of cheap imports than a loss of export markets in the case of a euro depreciation because these industries are net importers. Meanwhile, the Solar Panel Manufacturing industry (22111e) displays more equal shares of imports and exports, meaning this industry’s operators would feel the impact on both sides. In general, this sector is expected to generate $36.5 billion in exports during 2012, 8.2% of which will be destined for the EU15 zone. Meanwhile, imports are expected to account for $87.0 billion, with 5.8% coming from the EU15. Import competition is likely to mount significantly for these manufacturers if the euro loses strength against the US dollar, threatening domestic electric component production.
American automobile manufacturers could also face a dire situation in the event of a drastic depreciation of the European currency. The Car and Automobile Manufacturing (33611a) is highly exposed to imports, which are expected to meet 72.8% of the industry’s domestic demand in 2012. Exports also make up a noteworthy 48.2% of revenue for these companies. Manufacturers of SUVs and light trucks (33611b) are less exposed to international trade (see table), but the auto manufacturing sector is still dependent on EU15 countries for its well-being. Of the $51.5-billion worth of exports this sector is expected to generate in 2012, 20.8% is destined for the EU15; of the $150.4 billion imported, 20.6% is estimated to come from this region. A weakening euro would hurt US car and truck manufacturers by limiting demand in key European export markets while increasing the competition from European-made automobiles.
Conclusion
The US dollar has depreciated over most the five years to 2012. However, current ongoing conditions in Europe threaten to decrease the euro’s strength against its trading partners’ currencies, giving the US dollar a potential boost. While this appreciation may be positive for some inward-facing and domestically dependent industries (e.g. personal services and consumer retail), many industries that depend on trade with the European Union stand to suffer. Those that compete with high volumes of imports from European nations face heightened threats from cheap imports, while those depending on Europe as an export market will face decreased demand and purchasing power. Others would, unfortunately, suffer from both heightened imports and a lack of demand for exports. IBISWorld has highlighted the industries that stand to lose out if the European sovereign debt crisis results in a weakening of the euro. Operators in this set of industries engage heavily in trade with Europe, leaving them high and dry in the scenario of euro depreciation.
To download full research reports for the industries discussed in this article, click on the report titles below.
Car and Automobile Manufacturing, Copper, Zinc and Lead Refining, Coal Mining, Plastic and Resin Manufacturing, Iron and Steel Manufacturing, Power Tools and Other General Purpose Machinery Manufacturing, Jewelry Manufacturing, Metalworking Machinery Manufacturing, Brand Name Pharmaceutical Manufacturing, Generic Pharmaceutical Manufacturing, Vitamin and Supplement Manufacturing, Engine and Turbine Manufacturing, Wind Turbine Manufacturing, Semiconductor and Circuit Manufacturing, Circuit Board and Electronic Component Manufacturing, Solar Panel Manufacturing, Car and Automobile Manufacturing, SUV and Light Truck Manufacturing
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