The introduction of the euro in the form of coins and colored notes marks the final stage of the three-year launch for the new currency, which could become a rival for the dollar and have some far-reaching effects on the U.S. economy. Depending on how it is accepted, the euro could ultimately become an alternative to the dollar as a global reserve currency and provide a place of refuge if mounting U.S. debt finally leads to a weaker dollar, according to international finance experts at Wharton and other research institutions. Finance professor
The introduction of the euro in the form of coins and colored notes marks the final stage of the three-year launch for the new currency, which could become a rival for the dollar and have some far-reaching effects on the U.S. economy. Depending on how it is accepted, the euro could ultimately become an alternative to the dollar as a global reserve currency and provide a place of refuge if mounting U.S. debt finally leads to a weaker dollar, according to international finance experts at Wharton and other research institutions.
Finance professorRichard Herring, director of The Joseph H. Lauder Institute of Management and International Studies, was in France earlier this month and reported that the transition is going smoothly. Herring did note, however, that some consumers have complained about shop owners using the euro as an excuse to hike the price of a baguette.
“In many ways the euro has succeeded even better than we thought,” said Herring. “But looking ahead, it is not yet obvious that it is going to displace the dollar as the primary vehicle in international currency transactions.”
While the euro may never reach the supremacy the dollar enjoys today, it is likely to become a respected equal over the long term, said finance professor Richard Marston, director of Wharton’s Weiss Center for International Financial Research: “I don’t think we’ll see a real tipping to the euro. The worst that can happen for the dollar is that the euro becomes as important. I think we will have a bi-polar world.”
In trade, the euro is already taking business from the dollar in transactions between European companies and non-U.S. businesses, he said. The dollar will continue to be used in U.S. trade with non-EU countries, but the key question will be how U.S.-EU sales will be handled. “The likely scenario, in 10 or 15 years, is that exports of some European commodities will be denominated in euros, and the U.S. will denominate exports in dollars.”
He said it is less clear whether international commodities, such as oil, which are now sold almost entirely in dollars, will ever convert to euros.
In finance, Marston noted that the euro is beginning to play a role in the development of a growing market for European corporate debt. But compared to the United States, that market remains small. “I suspect that on the trade side we’ll see greater use of euros sooner rather than later,” he said. “In financial markets, the euro has a lot of catching up to do.”
According to finance professor N. Bulent Gultekin, the rise of the euro could reduce the cushion that U.S. consumers get from the dollar’s global stature. “People all around the world accept U.S. dollars and they cost us nothing to print. That allows us to have protracted deficits and an imbalance of trade. Basically we’re financing our consumption for nothing.”
Gultekin said countries are likely to buy euros as a reserve currency to diversify the holdings that back up their own money. He projected that eventually the euro could account for half of all reserves. Already, according to Herring, the Chinese government has had negotiations with Europe about buying euros as a reserve currency. Other countries, such as Iran, that view the dollar as politically incorrect might also be interested in switching to the euro. Drug lords, added Marston, may also diversify from dollars and marks to the euro.
Euro or no, analysts said, the U.S. current account deficit will eventually erode the value of the dollar. The U.S. currency has been riding enthusiasm for the U.S. economy over Europe and the rest of the world, despite the recent stock market plunge and the current economic softening.
Capital flows into the U.S. rose from $111 billion in 1996 to $400 billion in 2000. Before foreigners can buy a share of stock or a bond, they must convert their home currency to dollars. “What will really trigger a turnaround is that at some point markets will stop focusing on relative growth and start focusing on the long-term debt buildup and a day of reckoning will arrive,” said William Cline, chief economist at the Institute of International Finance in Washington, D.C. That day could come in around five years, Cline estimated.
The euro, which began to circulate January 1 in eight denominations of coins and seven bank notes, is now the combined currency of 12 nations and 300 million people, with an economy as large as the United States and expected to grow larger. But the dollar, said Herring, has an outsized role in the global economy. It is used four times more in transactions than the U.S. share of total world output.
He said the current euro holdouts – Britain, Sweden and Denmark – are likely to sign on soon. The euro ultimately may be adopted by another 10 or 11 countries in Southern and Eastern Europe. “That’s a lot of heft. There is another game in town now.”
First introduced for use in electronic financial transactions in 1999, the euro got off to a slow start. It began trading at $1.18 per euro and has gone on to lose a quarter of its value. “The decline of the euro from its launch, which has been quite sharp, has raised some questions,” said Cline. “You see some rumblings from the Italians in particular that might suggest doubts about the long-term sustainability. But the best bet is the euro is here to stay.
Hann-Ju Ho, an economist in the London office of the research firm Stone & McCarthy, said the euro should reach parity with the dollar in several years. “In the short term there’s still a lot of uncertainty about the currency. Once the changeover into cash is completed, I think we’ll get a clear picture about where the euro will go. All the estimates indicate the euro is undervalued against the dollar.”
So far, European policy makers have done a good job in building economic systems to back up their new currency, said Herring. However, despite their unified monetary policy and currency, it might still be difficult politically to manage fiscal policy if different countries face cyclical problems at the same time, he warned.
But the future of the euro-dollar relationship will be determined not by what Europe does right, but by what the U.S. does wrong, said Herring. He pointed out that following World War I, long after Britain’s economic superiority had been lost, its Sterling remained the world’s primary currency, until a botched devaluation and other policy debacles.
“Once you have a particular currency that’s dominant, it takes a strong reason to roll out of it,” said Herring. “But if the U.S. has hyperinflation or imposes capital controls, or if our current account balance should start to soar again so people worry about the solvency of the dollar, there is now a very ready substitute.”