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Is the Euro undervalued?

This morning my daughter asked me why the people on the telly were talking about currencies. Other than a feeling of pride, I also felt slightly panicked. How do you explain the currency markets to a seven-year-old, and the impact the value of a currency can subsequently have on trade?

The story she had picked up on were the comments from Peter Navarro, the head of President Trump’s National Trade Council. Navarro alleged that Germany was manipulating the value of the Euro to benefit its own trade.

Currency and trade

The new US administration is very focussed on trade and the economic impact this can have. If goods can be imported more cheaply than they can be produced, that could lead to a reduction in domestic jobs in that area. The new administration is paying a great deal of attention to their trade balance for this reason. They currently have a deficit with Germany, the US is buying more German goods than Germany buys American products.

The exchange rate is one factor that can drive the competitiveness of an industry. If a currency is weak then the goods from that country are cheaper to buy, this is part of the reason the FTSE100 has done so well since the Brexit vote. If we look to the US, the dollar is currently strong, due to a combination of a promise of increased fiscal spending and an already robust economy.

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A weak Euro

Now you could argue, and some experts have this week, that Germany has benefitted from a weaker Euro. If Germany had its own standalone currency they’d likely be in similar situation to the US because their economy is strong. German goods would be more expensive and so less competitive against their US counterpart. Arguably Eurozone policy has helped Germany to grow whilst keeping their goods ‘cheap’.

However, can you really say that Germany is keeping the value of the Euro low? Monetary policy would surely be different if the Bundesbank operated alone? Instead, they have to consider economies at different stages, such as Greece, Spain and Italy. The US have flagged this because the currency value combined with the level of trade looks a little suspicious, but the same could be said of certain US states. What if California, say, had its own currency. Maybe its goods would be more expensive to export.

Now how did I explain this to my daughter? I tried with biscuits, ten American biscuits, five English biscuits, ultimately she ended up eating far too much sugar and being none the wiser. But if she’s asking these questions at seven, hopefully that’s quite promising. For the investors of you out there, the rhetoric around trade and focus on trade deficits could mean we see increased volatility in trade policy and currency markets.

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