Does Euro Spell End of the Dollar?

Eleven European nations unveiled a new common currency on Friday, and millions of American eyes glazed over at the thought. “Whatever it is, it has absolutely no effect on me,” a typically bored worker at a Times Square deli told a Wall Street Journal reporter who asked him about the euro. Duller than utility deregulation, as incomprehensible as Whitewater, more important than the North American Free Trade Agreement, the dawn of the euro is, next to Social Security reform, the great journalistic nightmare of our time. Not even media mogul Rupert Murdoch can get a catchy headline out of this story: “Eleven European Nations Move Cautiously Toward Currency Union.” It’s no “Ford to City: Drop Dead.”

In one sense, the Times Square deli man had it right. For at least two more years, the euro will only be a unit of account, a kind of virtual money that only exists in computers. There won’t be any euro coins or bank notes; euros won’t be used in stores. Travelers to Europe will still deal with lira, schillings, kroner, pesetas, deutsch marks and francs, and the number of francs, marks and lira Americans get for their dollars will continue to vary from day to day. Even in 2001, when euro notes and coins appear, most Americans figure that euros will be like the metric system or French: annoying, foreign and tricky, but something you only have to deal with abroad.

Don’t be fooled. This meek and mild-mannered Clark Kent of a story is really the Superman of financial news. The euro is likely to affect the economic well-being of everybody in the United States. At best, it could unleash a new period of prosperity and growth in Europe that could propel the world economy to new highs in the next century; at worst it could threaten world peace.

The euro is important because, for the first time since World War II, there will be a money that, potentially, can challenge the dollar’s role as the world’s major currency. Since the value of the dollar, like the value of anything else, is based on the balance between supply and demand, a fall in international demand for the dollar could result in a serious fall in its value.

The United States has been lucky since World War II. Demand for the dollar has stayed high because corporations, governments, banks and private citizens abroad have chosen to keep large portions of their assets in dollars, or in dollar-denominated assets like U.S. stocks and bonds. Take the extreme example of Russia: Millions of Russians are keeping billions of dollars under their mattresses because they don’t trust either Russian rubles or Russian banks. Around the world, central banks keep most of their foreign reserves in dollars. The Bank of China has about $162-billion worth of foreign reserves, 62% of that in dollars.

Facts like this matter. When foreigners hold their savings in dollars, it is as if the people you wrote checks to didn’t cash them but kept them stored safely away. If that happened, you could write a lot more checks than you had money in the bank, and nobody would care. In essence, that is what the United States has been able to do since World War II: write checks that we knew would never be cashed because foreign governments and private citizens wanted to hold onto our IOUs. This is how the U.S. has been able to afford such large trade deficits and government budget deficits with so little pain: Foreigners have been willing to hold large dollar balances.

The euro may end that happy state of affairs. Up until Dec. 31, 1998, there were no good alternatives to the dollar for foreigners who wanted to shelter assets. While Russians keep dollars in cash, many others prefer to earn interest on their reserves. When you are really rich, like a central bank with hundreds of billions of dollars worth of assets, there haven’t been many good alternatives to U.S. debt markets. If you need to sell $10 billion of U.S. Treasury bonds, the market is so big your sell orders won’t send it into a panic. A comparable order to sell, say, Danish government securities, could swamp the market.

But when you take the debt markets of the 11 euro countries--Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain--and add them together, you have a capital market as deep as that of the United States. The euro, therefore, gives many organizations their first realistic alternative to the dollar for very large portfolios. The Bank of China already is planning to decrease its dollar holdings from 62% of its portfolio to 50%, while increasing its weighting both in the yen and the euro. One problem for the dollar is that this portfolio shift could accelerate into a feeding frenzy. As big investors abandon dollars, the price of the dollar compared to other currencies could fall, leading more people to shift money out of the dollar, depressing its value still farther. That could turn ugly fast, and once the euro is in place, preventing a dollar free fall will become a long-term concern for U.S. policy-makers.

There’s another problem. Since World War II, the Federal Reserve of the United States has been, in effect, the central bank of the world. Increasingly, Fed chairmen have understood that their job was bigger than simply managing the U.S. economy; to some extent, they had to make economic policy for the whole world. Federal Reserve Board Chairman Alan Greenspan dramatically demonstrated how that works last fall, when he cut interest rates three times to stop what otherwise might have turned into a 1930s-style global depression.

With the rise of the euro, Greenspan and his successors won’t have as much freedom to act decisively. In the future, if the Fed cuts rates to fight global recession, many investors will shift out of the dollar into the euro, depressing the dollar and contributing to inflation in the U.S. When that starts to happen, Fed chairmen will have to think less about the rest of the world and more about the stability of the dollar. That won’t be good news for Europeans--or anybody else.

Hopefully, the newly powerful European central bankers running the euro will work cooperatively with the Fed to keep the world economy strong. But there is no guarantee. Historically, some of the most dangerous financial panics have occurred when a new monetary power has become strong, but has not yet learned through experience that it cannot neglect its global responsibilities. Both the Bank of England in the 19th century and the Fed in the 1920s and ‘30s put the world through some difficult moments as they learned to balance domestic and international responsibilities.

On the other hand, the euro could be extremely beneficial to the U.S. and the world. If the new single currency unleashes, as some hope, a wave of growth in Europe, that would be good for exporters in the U.S. and Asia and good news for the whole world economy.

So will we get the good euro or the bad euro? Too early to tell, and for people in journalism, that is bad news. This story is going to be around for a long time, and that means plenty more heavy lifting as we try to report this dull, complex but important subject in a way that is interesting, accurate and fair.