Quotes of the Day

Buy a Porsche 911 Carrera sports car and get a Porsche Cayenne sport- utility vehicle free! Some kind of tacky promotion? No, it's actually one of the most striking consequences of the sharp rise in the value of the euro against the U.S. dollar over the past few months. At the current exchange rate, German and other European luxury cars now sell for far less in the U.S. than they do in Europe, anywhere between €5,000 less for a Mercedes E320 to €85,000 less for a Rolls Royce Phantom, according to Ferdinand Dudenhöffer, a German auto-industry consultant. The €60,000 difference between the top-of-the-line Carrera GT in America and in Germany is, he calculates, enough to pay for the Cayenne.

That might be great news for the few car lovers prepared to cross the Atlantic, but it's murder for Europe's car manufacturers. Indeed, many argue that the biggest threat to Europe's economic recovery is the soaring euro, which is up by more than 25% against the dollar in the past year and more than 40% higher than it was two years ago. Exporters, who account for about 20% of Europe's GDP, are in a squeeze. If they raise their prices abroad to compensate, they risk losing business to their competitors; if they don't, their profit margins disappear. Policymakers are in a squeeze, too. Despite healthy signs of growth in the U.S. and elsewhere, the strong euro is putting the brakes on an export-led recovery, raising the prospect that the euro-zone economy could remain stuck in a ditch for a second year in a row. "You can understand the frustration of European governments: just when they hoped to benefit from the upturn, there's a Damocles Sword of exchange rates hanging over it," says Olivier Garnier, director of strategy at SG Asset Management in Paris.

Inevitably, there's a chorus of alarm — and some recriminations. German Chancellor Gerhard Schröder last week raised his concerns directly with Alan Greenspan, the chairman of the Federal Reserve, in a meeting in Berlin, saying that he was worried about the abrupt exchange-rate movements. In France, Finance Minister Francis Mer told Parliament he wants the G-7 countries — including the U.S. and Japan — to "send the right signal" about the weak dollar when they meet in Florida next month. Some even see a conspiracy: by running up huge trade and budget deficits, the theory holds, the U.S. is deliberately allowing its currency to slide to punish "old" Europe and pump up its own growth in a presidential election year. That theory was given some credence by the International Monetary Fund when it warned earlier this month that the burgeoning U.S. deficits posed a threat to the global economy.

But not everyone subscribes to it. "What irritates me is the hunt for a scapegoat," says French economist Albert Merlin. The dollar, he says, "is not the primordial preoccupation for the Americans, it's our problem." Greenspan, for one, agrees. In Berlin, he argued that the dollar's decline wasn't fueling inflation, damaging the U.S. economy or endangering a global recovery, but he did concede that it's hurting European exporters.

And the hurt is widespread. The big German business-software company SAP last week reported that its sales in euros had fallen in the most recent quarter, and it partly blamed the weak dollar. At aerospace firm EADS, chief executive Philippe Camus frets that the strong euro will more than wipe out any gains from the firm's efforts to reduce production costs. And smaller players are feeling the pinch strongly, too. "It makes business enormously difficult," says Rainer Hundsdörfer, chief executive of Weinig Group, a producer of woodwork machinery based in Tauberbischofsheim, Germany. Exports account for 90% of the firm's €320 million in annual sales. Hundsdörfer says that while it can raise some prices, it can't fully compensate for the currency losses.

Can anything be done to mitigate the pain? All eyes are now on the European Central Bank. It could intervene in foreign-exchange markets, selling euros and buying dollars in a bid to at least stem the European currency's rise — although its occasional interventions in the past have usually been done in concert with Japan and others. More radically, the bank could cut interest rates further. That would make the euro less attractive to investors, and give an extra impetus to domestic demand in the 12 nations that have adopted the single currency.

But the Central Bank's new president, Jean-Claude Trichet, has so far shown no public inclination to do either. As the former head of the Bank of France, he has a wealth of experience dealing with out-of-control currencies — and a track record that suggests he isn't fazed by them. He hiked French interest rates to keep the franc on par with the surging German mark during the last major bout of dollar weakness in the 1990s, a move that pushed France into recession. So far, his public verdict on the strong euro is that it doesn't yet pose a real risk to the European economy.

Still, even Trichet is beginning to worry. Last week, he helped to push the euro back down a tad by talking about its "brutal" increase and grumbling about "excessive volatility." But few expect him to follow up with action anytime soon, unless the European economic outlook suddenly weakens. "The light is flashing amber," says Mark Wall, a European economist at Deutsche Bank in London.

It's not just the dollar that's a problem. The pound sterling, while strong against the dollar, has been falling against the euro, helping Britain far outperform euro-zone economies by making its exports to the rest of Europe more competitive. But for all the worries, many economists and businesses in Europe remain relatively upbeat. Stock markets across the Continent are at their highest levels in three years, and a survey of France's biggest listed companies by Le Monde this month showed that most of them plan to increase their investments this year. The euro zone averaged growth of just 0.5% last year; for 2004, Deutsche Bank and others forecast an increase of between 1.5% and 2%. For all the damage that a strong euro does, it has its benefits, too: it cuts the cost of imports and brings down energy prices.

And anecdotal evidence suggests that the single currency itself may provide a buffer against currency turmoil. At the German Engineering Federation, whose 3,000 corporate members have combined sales of about €140 billion, chief economist Ralph Wiechers points out that while 70% of production goes for export, half of that is to other European nations that have the euro, and thus unaffected by the currency's appreciation. A decade ago, the situation was more dramatic because only about 30% of the firms' production was sold to customers who paid in German marks, leaving them more vulnerable to currency fluctuations. "Europe is our home market now," Wiechers says. As for the euro's strength, "it does affect our business," he says, "but it's not a reason to panic."

For now, businesses need to find a way to muddle through. Machine producer Hundsdörfer's strategy: to buy parts increasingly outside Europe and build up the firm's own production in China, where it first set up a factory in 1996. "Our next step is to export from China to the rest of Asia," he says. What's missing in all this is the European consumer; their confidence remains weak. To get a real recovery going, economists agree, will require households to break open their piggy banks. So if European drivers start crossing the Atlantic to snap up those Porsche Carreras at a bargain price, take it as a good sign.

• PETER GUMBEL
• The dollar's slide hurts the euro zone