NCPA - National Center for Policy Analysis


October 31, 2005

The dollar is the world's number one reserve currency. However, recent changes in the economic world may change that. A new article from the Economist argues that the euro may eventually equal the dollar as a reserve currency or even surpass it.

Reserve currencies need to have a home economy with a large share of global output, trade and finance. America's economy still dominates, but the euro area is not much smaller. Moreover, the United States is facing some economic difficulties:

  • America's current-account deficit is the highest on record at 6 percent.
  • At 22 percent of gross domestic product (GDP), American net foreign liabilities are close to an all-time high.
  • Foreign central banks seem to have reduced their purchases of American Treasuries; official holdings of these rose by only $2 billion in the first seven months of 2005, against $295 billion in 2004 and $175 billion in 2003.

A group of economists studied the world money supply and modeled certain scenarios where the euro would surpass the dollar. They estimate that:

  • Supposing the dollar lost 3.6 percent a year against a basket of other currencies, while the euro gains 4.6 percent a year, the euro could become the top currency by 2024.
  • Additionally, if Britain, Sweden, Denmark and all the central and eastern European countries that joined the European Union last year adopted the euro, it would supersede the dollar by 2019.

Of course, Europe has it own economic difficulties, says the Economist -- stagnant economic growth, undeveloped financial markets, and burdensome levels of government.

Source: "Currency competition," The Economist, October 1, 2005.

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