The Euro vs. the Dollar

The following questions came from a former student:
"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. It might happen in 15 years or less if the UK joins the European Monetary Union and the United States continues to run current account deficits. A contributing factor will be that the petroleum states buy mostly in euros. Also, in 15 years the Chinese renminbi and Indian rupee will be much more important as trading and reserve currencies.
2. If the euro becomes the dominant currency, it is likely that London will once again eclipse New York City as the dominant financial center. The pound sterling used to be the world's dominant currency 100 years ago. I don't think that it matters very much for the aggregated 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. 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 of many years of excessive borrowing by the United States - both budget deficits and current-account deficits. 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 its deficits.
3. Strength in the euro and other countries is by definition weakness of the dollar. The dollar has been trending downwards for years. 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.