The Power of the Falling Dollar

The declining dollar means VW's new Scirocco won't be coming to the U.S. after all. Other exports from the euro zone are taking a hit, too

by Jack Ewing

Volkswagen's redesigned Scirocco was one of the hits of the Geneva auto show (BusinessWeek.com, 3/4/08) in early March, drawing crowds of admirers and adding some much-needed pizzazz to the German automaker's lineup. The sporty car might be just the thing to revive the Volkswagen (VOWG.DE) brand's image in the U.S.

But don't expect to see the Scirocco, built in euro territory, cruising down American highways anytime soon, even though VW engineers designed it to meet U.S. requirements. "At the current exchange rate there's no point," says Detlef Wittig, VW executive vice-president for group sales and marketing. "There's no profitability there."

Exports Suffer

As the dollar nears lows last seen in 1995, it's forcing a radical rewrite of business plans all over Europe. Some companies, such as local retailers, benefit from lower import costs, but those that manufacture in the euro zone and sell in the U.S. or Asia are facing a serious competitive disadvantage. The euro bought more than $1.54 on Mar. 7, an increase of over 80% since October, 2000, making it difficult if not impossible for European goods to compete on price with products made in the U.S. Charles Edelstenne, chief executive of French aircraft maker Dassault Aviation (AVMD.PA) and head of the French aerospace manufacturers association, says the pain in his sector is the worst he has seen in nearly 40 years.

The big disappointment is that Europe has worked so hard in the last decade to protect itself from just this kind of currency market tyranny. After the last dollar-induced crisis in the mid-1990s, many companies set up operations in the U.S. and Asia so that shifts in currency values would tend to balance each other out—so-called natural hedging. They also protect against currency swings with sophisticated hedging techniques. And the euro itself, introduced in 1999, eliminated currency risk for trade among the 15 nations who use it. Most European countries are still each others' largest trading partners.

But such measures go only so far, particularly for countries and companies that depend on exports. Ireland, which uses the euro, has been hit by a double whammy, because the currency has risen against the British pound as well as the dollar, making Irish exports more costly for its two largest trading partners.

Outsourcing Operations

"I see the negative impact of exchange rates as the final nail in the coffin for [some] companies," says Jim Power, chief economist at Friends First, a financial-services group in Dublin. "It's not necessarily the one that will drive them to the wall but one that will drive them to relocate their operations offshore."

German automakers, whose production is still concentrated in the euro region, are feeling some of the most acute pain—and there's no quick fix. The obvious step is for them to boost production in America. BMW (BMWG.DE), for example, is ramping up output at its plant in Spartanburg, S.C., by 60%, to 240,000 vehicles. The carmaker is also encouraging suppliers to produce more in the U.S. or other countries whose currencies track the dollar.

Volkswagen is scouting for a location to build a U.S. plant, adding to existing production capacity in Mexico. But factories take several years to come on line. "It's not a six-month process," says BMW Chief Financial Officer Michael Ganal. In the meantime, shorter-term measures are required. BMW is cutting more than 8,000 jobs (BusinessWeek.com, 2/27/08) primarily in Germany, to reduce its personnel costs by $770 million.

Global Demand

Despite the rising exchange rate, European growth is so far holding up surprisingly well. German exports rose 9% in January compared to a year earlier, the Federal Statistics Office said Mar. 10. And a strong euro is positive for retailers and other importers who buy products from Asia and sell them in Europe. The currency rate also helps offset the effect of rising energy prices for European companies and consumers, since most energy is priced in dollars.

In addition, the negative effects of the euro have been muted by continued strong demand from China and other emerging economies. But as the U.S. economy slows and American consumers buy fewer foreign-made goods, Asian manufacturers may in turn curtail their purchase of German-made factory machinery and other European products.

"The exchange rate could compound the effects of weakening global demand," says Jacques Cailloux, chief euro area economist at Royal Bank of Scotland (RBS). The dollar may be weak, but its power to disrupt the global economy is still almighty.

With reporting from Kerry Capell in London and Carol Matlack in Paris.

Ewing is BusinessWeek's European regional editor .