Commentary Type

It's Not Just About the Money

Article in the International Economy


Financial panics are indeed dramatic and, for many private individuals and economic policymakers, traumatic. They are rarely of lasting significance to the fate of nations or their currencies, however, as the prompt recovery of Korea, Mexico, and Russia from their travails a decade ago demonstrates—as indeed does the lack of any lasting impact from the United States’ closing of the “gold window” on the dollar’s standing or on U.S. economic performance. Though such calm is difficult to maintain while the United States experiences a panic in its many interlocking asset-backed securities markets, following years of large current account deficits and a concurrent sell-off of the dollar against the euro, it would be a mistake to read too much into recent developments. In fact, they obscure the reality that the euro is at a temporary peak of influence, and the dollar will continue to benefit from the geopolitical sources of its global role which the euro cannot yet or soon, if ever, match.

Given the apparent readiness of the euro to provide an alternative for all these concerned individuals to accept in lieu of dollars, or even into which to switch their investments, the euro’s ascent to at least comparable status with the dollar has a surface and popular plausibility. The fundamental drivers of reserve currency shares are usually thought to be relative economic size, financial depth, and commitment to low inflation of the relevant currency blocs, all of which could be expected to converge over time with the United States, if not favor the euro. The only offset to this projected trend of increasing euro usage usually admitted is the obvious inertia in dollar usage shown in the data, which is usually ascribed to incumbency advantages due to the net- work benefits from the already wide use of the dollar.

Some analysts have argued that the euro’s attaining co-dominance simply awaited a significant series of policy mistakes or a balance of payments crisis on the part of the United States to overcome this inertia. Such a process is assumed in those analysts’ interpretation to have been operative when sterling lost its role to the dollar in the 1930s, once the United Kingdom’s balance of payments and monetary discipline flagged, and the dollar was spared such a fate in turn during the 1970s only because neither the deutschemark nor the yen were a viable alternative at the time.

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