High Euro Leading to Fall in Long-Term Investment

Policymakers in Europe have been worried about the appreciation of the euro, which makes local goods less competitive in international markets. Another cost of the currency’s strength is that foreign direct investment has plummeted, as producers shift funds to nations that now have a cost advantage.

From the Telegraph:

Long-term private investors are pulling their money out of the eurozone at the fastest rate since the creation of the single currency, according to a report by the French bank BNP Paribas.

Foreign direct investment (FDI) in plant and factories has turned deeply negative, reaching minus €149bn (£117bn) over the past year. It dropped to minus €19bn in March alone as the soaring euro pushed labour costs in southern Europe to uncompetitive levels.

The annual exodus of private funds from eurozone equities and bonds has reached almost $280bn. Taken together, the total outflows have topped €400bn in 12 months and may spell trouble for Europe’s industry as the economic downturn gathers pace.

Airbus is leading the rush to hollow out production inside the currency bloc, switching operations to the US, Mexico and India. “It really worries me that private accounts are selling assets like this,” said Hans Redeker, BNP’s currency chief.

The euro is being held aloft by central banks in Asia, Russia, and the Middle East seeking an alternative to the dollar as a place to park their mushrooming currency reserves. In effect, the eurozone is now suffering from the reserve currency curse.

While Asian funding has helped ease the credit crisis in Europe, it has also pushed the exchange rate to damaging levels. There is a trade-off effect. The eurozone has gained financial flows, but has lost industrial and investment flows….

The eurozone racked up a record current account deficit of €15.3bn in March, seasonally adjusted. BNP Paribas said the so-called “PIGS” (Portugal, Italy, Greece, and Spain) are dragging down the trade performance of the bloc.

All have suffered a relentless loss of competitiveness since EMU was launched. The deficits have reached 10pc of GDP in Spain and 14pc in Greece. None has begun to narrow the gap in unit labour costs with Germany, ensuring that the inevitable adjustment will be more severe when it comes.

Indeed, Spain’s inflation surged to a record 4.7pc in May. The country now faces the most acute “stagflation crisis” in the developed world. House prices have fallen 15pc nationwide since September, according to the developers’ association (APCE). Madrid University warned this week that Spain’s property slump could throw 1.1m people out of work.

Mr Redeker said the ‘PIGS’ quartet was now facing “collapse”, with mounting signs of stress in France as well after consumer confidence fell to the lowest level in 20 years. French property sales fell 28pc in the first quarter.

“There are a lot of ugly surprises in store as deleveraging finally hits Europe. Investors are going to stop treating the eurozone as if it were Germany, and take very close look at the deficits of the southern countries. We can expect bond spreads to widen significantly,” he said. “We will discover in this downturn whether the eurozone is really an ‘optimal currency area’. This is the test.”