Monday, March 24, 2008

EURO | Will It Eclipse the Dollar? Not Yet. (Updated May 4, 2016)

Faith in the Euro peaked at the end of 2009.
Fear peaked ion June 2010. Swings have been
narrowing around €1.30 to the dollar.
March 4, 2008–The following three questions came to me from a former student in one of the finance courses I have taught:
"1. Do you think the euro will become the worldwide dominant currency?
2. Say hypothetically if that would happen, what do you think would happen to the world economy?
3. And how would it affect the U.S. dollar?
If you could give me your personal opinion on these questions, it would be a great."

1. Might Happen, If... It might take 15 years and it would depend on the UK joining the European Monetary Union and the United States continuing to run big current-account deficits. A contributing factor could be that the petroleum states buy mostly in euros. Also, in 15 years the Chinese renminbi and Indian rupee will be more important as trading and reserve currencies.

2. The City of London Would Gain on Wall Street. The pound sterling used to be the world's dominant currency 100 years ago. I don't think that it matters as much for the aggregate world economy whether the dollar or the euro is dominant, but it will matter a lot to the United States and New York City. It would actually be a good sign if the UK joins the EMU because it will mean that the world economy is working well, and specifically the EU is working. The European economy with the UK will be larger than the U.S. economy. On the other hand, the speed with which the euro takes over might be a result more than anything else from  many years of excessive borrowing by the United States–both budget deficits (most money we owe to ourselves) and current-account deficits (scarier money we owe to other countries). If the euro strengthens, it would be possible to speculate more easily against the dollar and it would be harder for the United States to borrow abroad to finance current-account deficits.

3. A Stronger Euro Means a Weaker Dollar.  Economic theory tells us that as the dollar gets weaker, our exports should be cheaper for overseas buyers and our exports should increase. Foreign imports should become more expensive and Americans should cut back on buying them. So supply-and-demand forces are supposed to reduce our trade and current-account deficits. However, these forces are taking a long time to have the predicted effects. One reason is that wage disparities are so great internationally that it takes a lot of adjustment to get within the range where the expected consequences occur. The United States is exporting higher wages and is importing lower wages. Eventually real wages will fall enough here and rise enough elsewhere that we will be competitive. But don't hold your breath waiting for this to happen.

Let me know if I have answered your questions.

Update May 4, 2016

It doesn't look as if the euro is going to replace the dollar yet! The UK is voting on whether to leave the limited partnership it has with the European Union. The idea that a properly functioning monetary union can exist in the absence of full political union is being challenged by the actions of debt-heavy countries like Greece, Spain and Italy. Independent monetary policies are incompatible with a monetary union if that means the sharing of a common currency.