Stretching the Euro

U.S. Inflation Has Not Been Higher

Source: Bloomberg

Even more telling than reported inflation are relative changes in the growth of the money supply; inflation, after all, is a monetary phenomenon. Without more money chasing goods and services in the U.S. than in Europe, it is difficult to see how our inflation levels can exceed theirs in the short term.

Does Relative Money Growth Matter

Source: Bloomberg

Our growth in money supply as measured by M2 -- and all of the usual caveats on measuring money discussed here in recent months -- has been lower than comparable growth in European M2 for nearly a year. Interestingly enough, the far more rapid expansion of American M2 in 2000 and 2001 occurred during the midst of the euro's prolonged slide.

Are There Greater Returns on Euro Assets?

European growth has been far slower as of late than has American growth; the year-over-year change in real GDP in Europe through the third quarter of 2003 was an anemic 0.3%, which is quite weak in comparison to the U.S. figure of 3.6% over the same period. Unless there have been some absolutely astonishing improvements in European productivity relative to us, there is nothing in the macroeconomic data to suggest higher returns on European assets that would make the euro more attractive.

Macroeconomic data look backward, but equity markets look forward. If we compare the relative performances of the Russell 3000 to the Morgan Stanley Euro Index over the past five years, we see an odd relationship between stock markets and the exchange rate. The relative equity index performance appears to lead changes in the euro, both during the unit's decline and especially on its way higher. It is almost as if stock markets react positively to the prospect of a weaker currency.

Stocks Have Led Currencies

Source: Bloomberg

The relative outperformance of U.S. equities ceased almost at the start of the general global rally in March 2003, and the two markets have moved higher in general parallel since then. Of course, American investors have enjoyed currency translation gains on their overseas holdings, while our European friends have been treated rudely at our hands.