Oil Well

Harrowing Tale of a Plunging Euro and Soaring Oil Prices

Oil Well

Fueled by soft European economic performance, soaring oil prices, and uncertainty about its prospects as a currency, the euro has slumped to all-time lows. Initially viewed as an embarrassment to euro diehards, the exchange rate is now causing genuine concern, not only in Europe, but in U.S. markets.


Source: Pacific Exchange Rate Service

 


Source: NYMEX closing price for WTI, courtesey of Berry Petroleum Online

Source: National Association of Realtors

For a U.S. multinational company with significant exports, the problem is a simple one. With a weak euro, European consumers are less able to buy American goods. This puts a hit on corporate earnings. On the supply side, a volcanic U.S. economy and a richly valued dollar have put imports at record levels. This, coupled with shrinking demand in Europe, has led to record trade deficits. These deficits, and a falling demand for goods produced in the United States, could ultimately threaten the health of the seemingly unstoppable U.S. economy.

And how does the price of crude oil factor into all of this? Prominently, very prominently indeed. Crude oil trades in U.S. dollars. Every time someone wants to buy oil, they convert local currency to dollars, and then buy oil. With the oil price more than doubling since its 1999 low, more than twice as much European currency needs to be converted to dollars before the oil is purchased. Compounding the effect in Europe (and affecting U.S. businesses as well) are the increased costs and lower productivity caused by rising oil costs.

And today President Clinton directed the release of 30 million barrels of oil from the government's emergency stockpile. Could such a straightforward plan save the world from a woeful plunge into darkness? No - but it very well could garner a few votes from the gas-guzzling American public.

In a different realm of government intervention, the European Central Bank and associated European governmental agencies have a woeful record at trying to woo currency markets into buying more euros. What was once seen as blundering, now has the appearance of a fundamental problem. Aside from Spain, most European economies have continued to show signs of weakness, and the euro is sitting near its all-time low.

As any good contrarian knows, this is often the sign that a reversion to the mean is at hand. Japan had its run in the 1980s. The United States has been going strong through much of the 1990s. Surely Europe's time has come. Or maybe not.

I'll go out on a limb and put on my prognosticator's cap. My feeling is that there are two major issues aside from the oil price and soft European economy that are holding the euro back. One is uncertainty about the whole euro project. The other is the upcoming presidential elections. Both events will pass into history in less than a year.

Obviously the euro plan is unprecedented. It is an ambitious project to merge many of the world's most powerful currencies. But, come hell or high water, it will happen in early 2002, when the Germans are forced to trade in their marks, the French their francs, and the Italians their lira.

Why, you ask, does the presidential election have to do with the euro? A lot, potentially. While Gore's oil dumping project is unlikely to significantly affect the European economy, a concerted effort to shore up the euro, backed by U.S. support, could. With the IMF already supporting efforts of major governments to buy large amounts of euros to prop up the exchange ratio, just the approval of the United States of such an endeavor could move the exchange rate up.

If I was a betting man, which of course I am not aside from having money in a broadly diversified portfolio of equities, bonds, and real estate, I would say that I see a reversion to the mean (if there can be such a thing in the currency's short history) for the beleaguered euro. The combination of U.S. support for euro stability, coupled with a new influx of European retirement investment, and above all the Europeans just making it past the switch to the euro should see a resurgence on the Continent. Go shore up your collection of Europe's old currencies while the getting is good.