Weak euro shows power to attract and repel

Blue-Chip US companies - including Intel, Coca-Cola, McDonald's, IBM, Xerox and Gillette - are repatriating lower profits from Europe because of the weak euro, which could cause the shares of many consumer staples to end the year several percentage points lower than expected.

The problem is that US companies must express all earnings in dollars. Their business may be flourishing in Europe but by the time profits are converted back into dollars, they don't look so good. McDonald's, which makes a quarter of its worldwide sales in Europe, explained this phenomenon in a recent report: "While the weakening euro, pound and other currencies affect our reported results, they don't reduce the number of Big Macs we're selling in the local markets."

There are several ways in which US firms can soften the impact of currency on earnings. Paying European staff in euros and producing locally helps, but since industry is no longer labour intensive, the result is not significant. Most US manufacturers charge higher prices on European markets, but this also reduces competitiveness.

The main method of hedging against weak foreign currency is to contract to sell euros at a specific rate six months to a year in advance.

Earlier this year the chairman of Boeing, Mr Philip Condit, complained that Boeing's costs were in dollars while its main competitor, Airbus Industrie, calculated its costs in euros. "If the dollar is relatively strong in effect, it gives Airbus a little better pricing advantage," Mr Condit admitted.

But the weak euro has its attractions for US firms: they can buy out European businesses or invest in infrastructure more cheaply. US analysts express blind faith that the euro will strengthen by up to 10 per cent next year. "Traders agree unanimously: the euro will come back," says one US investment adviser in Paris. He repeatedly cites lack of confidence in the euro as the main cause of its weakness.

But he discounted the argument that once the public had euro coins and banknotes in their hands the currency would rise. "People have roubles in their hands, and it doesn't make any difference." Sooner or later something will reverse the trend, a second analyst added. "But for the euro to appreciate, Europe has to do something right."

It can only help when European finance ministers agree to harmonise taxation on savings - as they did in Brussels on Monday. But French economists see deeper structural explanations for the currency's weakness.

"If the euro is low, it's because European businesses are investing a lot in the US and Asia. They're selling euros and buying dollars," says Mr Xavier Timbeau of the OFCE economic analysis group. French group Vivendi's recent acquisition of Universal studios and Renault's purchase of substantial shares in Nissan and Daewoo are examples. "If the euro is low because European business is massively investing abroad; it's a good thing," Mr Timbeau says.

He's encouraged that more companies and governments - especially in Asia, but including the Iraqi petroleum industry - are maintaining part of their treasury in euros. "The demand for euros is rising," he says.

Mr Yann Tampereau, an economist with the investment bank CDC Marches, is more pessimistic. True, he said, European companies were more competitive thanks to the low euro but the high cost of imports - especially raw materials and fuel - tended to neutralise the competitive advantage. And it produces inflation - above 2 per cent throughout the euro zone - which brakes consumption and slows growth.

"The low euro is a far bigger problem for the Europeans than for the Americans," Mr Tampereau says. "The depreciation of the euro is importing inflation."

Judging strictly from critera such as the difference between US and EU growth rates, potential growth and productivity, Mr Tampereau says the euro could be equal or slightly above the dollar. But capital flight from the euro to the dollar is the result of higher potential growth in the US over the long term. He predicts 3.75 to 4 per cent growth in the US next year, compared to 2.5 to 3 per cent in the euro zone.

"That's what makes investors decide for the long term," he says.

Even if there is a slowdown in the US, America will continue to benefit from a fluid labour market, past investment in infrastructure that was greater than Europe's and higher productivity. "The ECB will have to intervene more often to keep the euro above 85 cents," Mr Tampereau predicts dispiritedly. "We believe there are deep structural reasons for its weakness."

The only thing Europe could do, he adds, is begin to make hard but necessary structural reforms and co-ordinate the disparate budgetary and fiscal policies that erode the euro's credibility.