Young euro threatens dollar supremacy


By Barrie McKenna
The Globe and Mail, Toronto
Thursday, January 18, 2007

WASHINGTON -- Flash the greenback just about anywhere in the world, and chances are you'll seal the deal.

The mighty U.S. dollar remains the world's default currency. Central banks keep two-thirds of their reserves in dollars.

Oil, gold, and most farm products are all priced in dollars. A little green will even get you a fake Prada handbag in Shanghai or a cab ride in Havana.

And yet the U.S. currency is facing its first serious challenge in decades from the infant euro, now five years old.

At the end of last year, the euro quietly reached a key milestone. The value of all euro notes in circulation exceeded the value of all dollars for the first time -- US$828 billion to to US$753-billion.

"The euro is the first currency in a hundred years that can really compete with the dollar on a global level," said Fred Bergsten, director of the Washington-based Peterson Institute for International Economics.

"The U.S. dollar has been the dominant currency because it's had no competition. The creation of the euro changes all that."

Within five or 10 years, half of all global finance could be conducted in euros, Mr. Bergsten predicted.

Meanwhile, a clutch of central banks have begun to cautiously shift some of their reserves into euros, including Russia, the United Arab Emirates, Qatar, Indonesia, Sweden, Venezuela, and Iran.

European central bankers can barely contain their glee. "The euro is becoming extremely attractive, as a vehicle, a transaction, an investment and a reserve currency," Bank of France governor Christian Noyer said in a recent speech.

"We are neither encouraging nor discouraging the process. But as a citizen I cannot help but feel proud of having one of the two main currencies in the world."

Mr. Noyer may be less proud of another sign of the euro's coming of age. The 500-euro note is reputedly becoming the currency of choice among arms smugglers and drug traffickers eager to escape the tracking of movements of large sums of U.S. dollars. They used to prefer hundred-dollar bills.

There are a few simple reasons for the euro's recent dominance in the global cash market. The euro zone, which recently welcomed Slovenia as its 13th member, is now larger than the United States by roughly 10 million people. And Europeans are far more likely to use cash than Americans, who favour credit and debit cards.

The change in sentiment among central bankers is more complex. But some of the reasons include last year's 11-percent fall in the dollar versus the euro, growing confidence in the stability of the euro, and the maturity of European financial markets, according to experts.

"The liquidity and breadth of euro financial markets are fast approaching those of dollar markets, and as a result the euro is eroding some of the advantages that have historically supported the preeminence of the U.S. dollar as a reserve currency," economists Gabriele Galati and Philip Wooldridge of the Bank for International Settlements concluded in a new working paper.

The economists found that Russia and members of OPEC have cut their U.S. dollar reserves to 65 percent in 2006 from 67 percent. Their share of euros correspondingly rose to 22 percent from 20 percent.

The U.S. dollar has been the world's dominant reserve currency since the Second World War. It now accounts for roughly 66 percent of the nearly $5-trillion held in the coffers of the world's central banks. That's up from about 50 percent at the end of the 1980s, but down slightly from an all-time peak of 70 percent in the late 1970s.

The share of reserves in euros has reached nearly 25 percent.

The British pound has overtaken the yen for third spot with 12 percent. About 5 percent are held in yen, down from 10 percent at the end of the 1980s.

The wild card in all this is China. It holds 20 percent of all foreign reserves, or roughly $1 trillion. And the bulk of that is believed to be in U.S. dollars.

Some Chinese banking officials have suggested they may want to diversify out of dollars. But there's no evidence that's happening yet.

"The big question for 2007 and beyond is whether China will do it" -- convert to euros, said Andrew Busch, global foreign exchange strategist at BMO Nesbitt Burns in Chicago. "It's a brave new world for them and we don't know what will drive that decision making."

Some economists said the recent excitement over the euro is overblown, and the dollar remains firmly entrenched as the world's reserve currency. "So far, the euro hasn't displaced the dollar as a reserve currency," said economist Peter Morici of the University of Maryland. "People talk a lot about it but it hasn't happened."

He said "Eurosclerosis" -- slow growth, an aging population, and restrictive labour rules -- will keep the euro a lesser currency for a while yet.

"Over time, the United States has earned the confidence of people that it will manage their paper assets," he said. "The things people want, they can buy with U.S. dollars. It's a true store of value."

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