The dollar versus the euro
Recent occurrences suggest that the greenback might just have a competitor on its hands, as the euro gains in stature
Recent occurrences suggest that the greenback might just have a competitor on its hands, as the euro gains in stature
As far as rates and the price of major exports and imports go, the dollar has been a stable world leader for decades. Recent trends in the global economy would suggest that the greenback’s incumbency in this position is in threat of usurpation given the growth, stability and wide-reaching trade of the euro.
Those trading deep in the American markets may consider this heresy. Indeed, several months ago Iran attempted to trade oil using the euro – in an attempt to upset the dollar as worldwide currency- and were battered by cries of outrage from the US. Understandably the worldwide consequences of replacing the dollar with a different currency as international benchmark would hit America and many of the world’s central banks with hard and lasting results.
Hegemony of the dollar
Few would remember a time when international trade was considered in terms of anything other than the dollar. One must go back to the pre First World War period to find sterling as the last international working currency. The sterling was dismounted, as the events beginning in August 1914 provided opportunity for the dollar to jump on the coat- tails of the high prices of gold it had at its disposal.
Since that last change, the past ninety years have seen few currencies strong or large enough to challenge or even have the potential to face the supremacy of the dollar. No other economy has come close to the internal and external size and weight of the dollar.
The greenback has sat aloft it’s perch looking down on a network of currencies all in competition with one another. These comparatively smaller currencies have had no where near the amount of network externalities that the dollar has commanded due to the hard-as-rock placemat that is the dollar. America’s commitment to the rule of law, free capital markets and price stability have over the course of time encouraged it’s credibility.
Even when the dollar hit turmoil over long periods of time few currencies were able to topple it as the world leader. Indeed, there have been many prolonged periods when the dollar has looked uncomfortable: the slow growth of the US economy over two decades beginning in the early 1970s; the high inflation experienced between 1973 and 1981 (including three years of double-digit price increases); and the large external deficits for over twenty years beginning in the 1990s. These potentially catastrophic periods would seem like perfect opportunities for another currency to take over as international trading currency, but the dollars survival only embeds its credibility.
Throughout these periods of difficulty, no other economy has been strong enough to take its place. There have been very few close calls, although some currencies have seemingly been in advantageous positions. After the Second World War, the deutsche mark became the world’s second largest currency. How close it was to overtaking the dollar is debateable, as it never attained a market share greater than a quarter of that of the dollar. Unsurprising, given that the former West German market was one-fourth the size of that in the US. Of course politics in the west at the time would never have allowed Germany such economic power. Another challenger was the Japanese yen, whose economy grew to nearly half that of the American recently but has never fully seemed to realise her potential.
When the euro initially became a physical reality, those relying on trading in American dollars must have considered the risk of an up-and-coming, fresh, and widespread currency. As speculation holds such a force in the markets, as do transitional considerations, the likelihood of a switch to Eurocentric economical supremacy adjusted the market sufficiently enough to upset dollar exchanges.
The rise of the euro and the fallings of the dollar
Two factors must occur for the euro to be classed as the dominant market trader. Firstly, the dollar must be on a severe low. As the greenback falls to its lowest rate since 2002, now seems like a good time for the euro to make great headway. Having said that, past evidence teaches us that the dollar will regain stability within an estimated five year period. Secondly, the euro must be in a strong position to overtake its rival. This is an incredibly political issue. Euroland supremacy and a coherent state are needed to even force the issue toward consideration.
The European Union and single government still has its doubters, which must be considered one of the greatest principles in protecting the dollar as the world’s heavy weight champion. The EU simply needs to attain credibility. Although the US maintains excellent GDP, considering Europe as a single unit makes output look more of a competitor. Europe is a strong place of investment for the US, hence the effects of the US credit crisis arriving on European shores. The problems hosted originally in America have led to the Federal Reserve Bank of New York being forced to make $24bn available to the European Central Bank and the Swiss National Bank in order to free up liquidity, which also further hits the rate of the dollar. Effectively, the US sub-prime mortgage losses contaminated worldwide money markets.
Whilst around 15 percent of European exports go to the US, 10 percent of American exports come to Europe. In 2006, European investment in America totalled €600bn, with €630bn from US firms being invested in the euro zone. Of course this shows the great amount of trade that goes on between Europe and the US, but by no means indicate a reliance: other major markets are vastly influential on where both nations stand. Whereas the US do business predominantly with Canada and the South Americas, more and more business is being carried out between Europe and the orient. Much more is happening between Europe, China and large firms in Japan. Macroeconomic policy is still being hindered by individual European states’ failure to posit themselves in a unilateral arrangement. Other issues such as climate change and the free movement of goods are debates that stoke up great debates in Brussels, discouraging real economic change. The major argument for the euro may come in its growth in worldwide foreign exchange reserves. Still far behind the dollar in worldwide reserves, the euro has seen excellent growth over the last few quarters. Indeed, it has outgrown the dollar on usage at a surprising rate, given recent dollar inflation figures.
Shifting trade and time for a change?
Whilst this may seem like the US are falling behind by shifting world markets, the dollar is still far from being dislodged by the euro. The role played by the greenback is still of huge significance to the European economy, and American exporters are benefiting significantly from trade abroad. Yet, domestically, questions are being asked of the US banking policies. Earlier in the year, American consumers were urged to spend large and save less. Although this freed up cash in the short term, it appears this was taken too far.
The current situation has alerted growing economies such as that of India and Russia, who may fancy a shift in order to cause a shake-up of worldwide US dominance. The change in the pricing of oil, for instance, would not only shift focus to Europe and the fluctuations of the euro, but the dollar would have far less weight in the markets. Another major issue for both the dollar and the euro would be the ramifications for most of the world’s bank’s reserves. Central banks hold most of their foreign exchange reserves in dollars. As countries would start to trade in euro, banks would be forced to exchange dollars for the newer currency, an issue the US would not take lightly. Further, the dollar being the universal hegemonic currency has allowed the US to distribute debt at a far cheaper rate. Resettling the exchange rate would also see banks on their knees, something they can ill afford at this time. Indeed, a massive loss in revenue would result in huge rises in interest rates for a period on both sides of the Atlantic. Of course there is no rule specifying that reserves can only be held in one currency, but the expense of branching out could be enormously expensive and impractical for trade with other banks.
With this in mind, it would seem that switching to a euro based economy would be beneficial to few, but in the long term the euro zone would hit new peaks. In a euro denominated economy, American banks would not be overwrought by having to provide funds for Europe. As the euro zone’s outward investment competes with America’s, it makes sense that self- reliance may be the way of the future for Europe. For weeks now, the credit market has been seized up. European banks have been injecting monies in order to free up the blockage, attempting to free up liquidity. Even if the EU were to get itself in another such mess, funds would be a lot easier to get hold of with the euro at hand from other countries. The US on the other hand, would no longer be able to afford another slip.
With the current crisis surrounding the markets showing no sign of wearing off, there are two ways the currency dilemma will play out. Firstly, make the euro the main trading unit. Short term, this seems unlikely, as the world’s central banks have distanced themselves from foreign currency interaction as a means to mending the recent problems. However, the European Central Bank has a mandate to establish the euro by whatever means necessary. Considering that, if European political leaders step in, chances are refuge will be sought using exchange rates as a counter balance. The long term solution for Europe will be relinquishing the dollar and working solely on the euro as a means of trade. Of course this will only happen if politicians across Europe start pulling in a similar direction. The second, and less overbearing short term answer is to support the stumbling dollar. At this point, it seems that all is down to politics, and out of the hands of the world’s leading bankers. This may all come down to the period surrounding the next American election, the US Treasury, and the European counterpart.
Looking long term
Take a few dollars and an AMEX card anywhere in the world, and you’ll be fine: a statement among the world’s elite that sprung up in the nineteen eighties. Is this something to be said of the euro in the next few years?
Some commentators has suggested that, like the last change that saw the dollar take over the sterling, war would need to occur for such a dramatic change to take place. Realistically, this isn’t such a threat to the dollar. However, the modern era of automated payments offers the potential of a terrorist attack on computer systems, which is something governments and major banks are petrified of. This could destroy the credibility of the dollar and pave the way for the euro.
