1/11/99 - OPINION: Why The Euro Won"t Dethrone The Dollar
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Jan. 11 (Bridge News)--By Alexei Bayer, economist and consultant
NEW YORK--The euro has made its debut on world currency markets to rave reviews. Amid the current euro-euphoria, who would be so churlish as to dredge up the dire warnings about the European single currency from 1996 and 1997?
At the time, it was feared that profligate governments across Europe would sabotage the euro by running budget deficits and letting their neighbors foot the bill. That the rock-solid German mark would be diluted by such softies as the Italian lira and the Spanish peseta.
Now all we hear is praise for the new currency, often from the same analysts who once were skeptical about the monetary union.
THE EURO, we"re now told, will not only be the darling of world financial markets but will rival the greenback in international transactions. In time, it may even emerge as a second reserve currency.
Certainly, the creation of the euro is a major milestone in the development of world financial markets.
A currency union of such scale has never been tried before and, if successful, may become a blueprint for similar systems in Southeast Asia or the Western Hemisphere.
It is already clear that the euro will be greater than the mere sum total of its constituent currencies, including the German mark. The development of European financial markets will take a dramatic leap forward.
The pan-European stock market that will probably emerge from the link between the Frankfurt and London exchanges will help boost stock investment in Europe, which lags behind the United States.
BUT CHALLENGE the world pre-eminence of the almighty dollar? That"s highly unlikely.
The dollar is the currency of choice for trade and savings the world over. Over 75 percent of the dollars in circulation are used outside the United States. This is not going to change.
Not only will Asia and Latin America continue to use dollars, Eastern Europe will as well. Over the past decade, Germany has become the largest trading partner of the emerging economies in Eastern Europe. The currencies of Hungary, Poland and other nations in the region are pegged mainly to the German mark.
But local traders still do business with each other in dollars. Similarly, while you can buy marks almost as easily as you can dollars at Moscow currency booths, it is U.S. dollars that Russian savers prefer to keep under their mattresses.
AS MUCH AS two-thirds of world trade deals are invoiced in U.S. dollars, as are most of U.S. imports and exports. Even such major economies as Japan face up to 50 percent invoicing in dollars. Most commodities, including such key ones as oil and gold, are priced in greenbacks.
Some analysts are now suggesting that since Western Europe accounts for nearly a third of world output and 21 percent of world trade, compared with 29 percent and 19 percent, respectively, for the United States, the euro will eventually become an alternative currency in which world trade will be billed.
This is also unlikely. The reason the dollar is used in international transactions is that it"s the one currency everyone can agree on. Uruguayan hide merchants sell their wares to South Korean customers in dollars.
THE DOLLAR PLAYS the role of a lingua franca of international commerce and finance. There is no room for two universal languages--as the French have found to their chagrin. Likewise, there can be but one universal currency.
Finally, what about the euro"s potential as a reserve currency? World central banks will doubtless hold more euros in their foreign exchange reserves--and this will make the world financial system more stable.
A second currency could protect the value of reserve holdings from falling if the dollar weakens against the euro, making central bank intervention in currency markets more effective. Accordingly, central banks in Asia have already started to rebalance their reserve holdings, replacing dollars with euros.
But even though central banks in Asia hold the world"s largest cache of reserves--Japan has over $200 billion, China some $140 billion--the worldwide composition of reserves is unlikely to change. U.S. dollars will still account for about 70 percent of total reserve holdings.
ONE REASON is that European central banks, which now hold each other"s currencies, will shift those holdings into dollars. But there is an even more compelling reason. Central banks hold relatively small portions of their reserves for the purpose of defending their currencies.
Reserves are more important than that. As the resource of last resort, they can be used in the case of an unforeseen contingency.
For this purpose, countries like to hold the most secure assets available. Even though economists have long said that gold is an anachronism, costing too much to store and guard and earning no interest, a substantial portion of world reserves still consist of those primitive gold bars.
GOLD IS a unique asset, used as a store of value throughout recorded history.
The U.S. dollar is similarly special. The United States is the military, political and economic guarantor of the world economic system. That"s why U.S. Treasury securities are rated higher than AAA and are the standard by which all creditworthiness is judged.
That"s also why world central bankers will continue to hold the bulk of their reserves in dollars--not euros, yen or any other currency that comes along.
The creation of the euro is an undeniable achievement. But just as euro-skepticism was premature, it"s too early to crown the euro a success just yet. As is often the case in financial markets, the early success of the new currency has bred unrealistic expectations and exaggerated claims on its behalf.
The euro will be an important currency. But as long as the United States remains the world"s only economic and military superpower, the euro will not dethrone or even achieve equality with the dollar. End
ALEXEI BAYER, an economist, is president of Kafan FX Information Services, a New York-based consulting firm. His views are not necessarily those of Bridge News.
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