Euro may become top reserve currency by 2022--study

[HenryTo]

This is one for the "Euro Bugs." This story sounds plausible should Great Britain join the Euro Zone - but otherwise it is very difficult to imagine how the Euro could be the dominant reserve currency in the foreseeable future. Stories like this usually come out just as a significant reversal is occuring (as I have mentioned before, the U.S. dollar's uptrend remains intact).
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Euro may become top reserve currency by 2022--study

WASHINGTON, Aug 5 (Reuters) - The euro could supplant the dollar as the world's dominant reserve currency within 20 years if Britain and other European Union countries adopted the unit and the greenback continues to slide, a recent study showed.

The paper, released by the National Bureau of Economic Research this week, outlined two key criteria for a change of the current status quo -- where about two thirds of world's central bank reserves are denominated in the U.S. currency.

First was the scope for expansion of the euro zone so that it tops the gross domestic product of the United States and envelops London's dominant international financial center.

Second is the role of U.S. economic policies and the risk that they might undermine confidence in the dollar through inflation and depreciation.

"We find that if all 13 EU members who are not currently in EMU (European Economic and Monetary Union) join it by 2020, including the United Kingdom, then the euro overtakes the dollar a few years later," the study's authors wrote.

"We also find that even if some of these countries do not join, a continuation of the recent depreciation trend of the dollar -- were it to occur for whatever reason -- could bring about the tipping point even sooner."

The study, written by Harvard University's Jeffrey Frankel and Menzie Chinn of the University of Wisconsin at Madison, said euro setbacks this year -- from sluggish growth and the rejection of the EU constitution -- were unlikely to delay for long the prospect of continued deficit-driven dollar losses in future.

"Our results suggest that such dollar depreciation would be no free lunch, and could have profound consequences for the functioning of the international monetary system," it said.

Debate resurfaced over the past year about the effects of rising U.S. international indebtedness on the dollar's prized reserve currency status, where the United States has a major advantage of borrowing from the rest of the world in its own currency.

The U.S. current account deficit has ballooned in recent years to about 6 percent of GDP and its outstanding stock of debts to the rest of the world has risen to 20 percent of GDP.

As world central bank reserves, particularly from Asia, have rocketed over the past three years as downward pressure on the dollar has mounted, speculation has grown that central banks may soon wish to diversify away from dollars.

Most economists reckon the euro is one of few sufficiently large and liquid alternative currencies.

The most recent data shows about 64 percent of the $3.81 trillion of world currency reserves are held in dollars and 20 percent in euros. But signs of diversification are mounting.

On July 21, China -- with the second biggest reserves hoard in the world at $711 billion -- changed its yuan target regime from a fixed dollar peg to one shadowing a basket of currencies.

On August 1, Russia -- with $114 billion of foreign currency reserves -- said it raised the share of euros in its day-to-day currency target basket to 35 percent from 30 percent and cut the dollar proportion to 65 percent from 70 percent.

There is also widespread speculation that Saudi Arabia -- with $112 billion of foreign reserves - may also change its strict dollar peg for a wider target basket.

The NBER study looked at several decades of reserve holding shifts, including the period when the dollar supplanted sterling as the dominant currency. It identified key determinants of these shifts and scenarios for the future.

"The euro gains overwhelming dominance in the instance where the UK joins the euro area and rapid (dollar) depreciation persists indefinitely," the study said.

"In this combination, the switchover occurs in 2020 and eventually the euro accounts for more than 80 percent of combined dollar and euro holdings."

[rffrydr]

Now apply the same reasoning to the yen

Euro still up on the year and one of the reasons is that asia, despite many abstract attempts, cannot pull off a currency block. Chinese gunboats severing the tethers on mapping trawler's in the South China Sea provides a hint of why this is so.

Meanwhile the region has been buying euros steadily this last few years attempting to work its way past our neo-mercantilism. Indeed, europe is now china's largest trading partner. Hollywood ending?
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

A blast from the past. Please see below.

Did I mention Germany and France in the previous post? As least I mentioned Italy! The question now is: Can the Euro in its current form survive to 2022?

[HenryTo]

distinct160,

Welcome aboard! It's always nice to get some new and fresh ideas here. I am sure that no one wants to hear me talk all the time.

I agree with your thinking, but in a world of paper currencies, every currency will depreciate over time. Basicially, one will need to pick out the currency that will best achieve their purposes - such as to facilitate trade, buy military items, or hedge or raise money in the world markets. For now, the US$ is still the best candidate for all these functions.

The US$ may not be looking good now, but the Euro - being a fiat currency as well - can also fall just as quickly. There is also a lack of fiscal discipline in countries such as France, Germany, and Italy. Moreover, the strength of a currency is also based on the economic strength of a country - such as the amount of wealth creation, how productive the population of the country is, etc. No amount of financial discipline can help a country if no significant amount of wealth is being created. Think Google, eBay, Yahoo, etc. - all very new U.S. companies which have created a significant amount of wealth in just the last ten years. It is very difficult to find such companies in other countries - perhaps China, India, and the UK come close but even they only would come in distant 2nds.

[distinct160]

During XVI century, the dutch florin was the main currency of trade while france was the dominant military power. The French king XIV used currency as way to pay its expenses while the ducth ensure that their currency hold value across time.

The first definition of a reserve currency : you buy something that will keep its value across time.

[HenryTo]

Bill,

Let me further expand your thoughts, and ask, what will cause the oil producers to change their mind re: "acceptance of said currency as payment for oil by a majority of producers, and/or pricing of oil in that currency in world spot markets?"

Or let me rephrase: What is the need to hold currency reserves? Currency reserves are held not just for the facilitation of everyday trade, but also for random shocks. To hold the status of having the reserve currency of the world, a country must be dominant in the following areas:

1) Militarily: A country should be asking - in the case of a war, where should we purchase our arms? Which country has the most dominant military technology in the world?

2) Have mature financial markets. i.e. when capital is needed in some kind of random shock, said country can raise capital very quickly. The question to ask here is: Why did Baidu.com (and a whole bunch of the better-run Chinese companies) decide to go public on the NASDAQ, and not the HK Stock Exchange or the London Stock Exchange (the French and German Exchanges were totally out of the question)?

For now, only the U.S. satisfies the two above criterias - along with being the best provider of liquidity (think NYMEX, ,CME, etc.) when it comes to the trading of commodities such as oil, gold, silver, copper, etc. This is all done in US$. The Euro only comes a distant second. To have a chance of replacing the US$ as a reserve currency, the Euro Zone will need to welcome the UK (after all, London can still be regarded as a world financial center) with open arms - and I just don't see that happening in the foreseeable future.

[nodoodahs]

IMO

For any currency to replace the USD as the world's "reserve currency," the key criteria will be acceptance of said currency as payment for oil by a majority of producers, and/or pricing of oil in that currency in world spot markets.

GDP is not a requirement. Oil demand by that currency holder should be high, however.

USD "confidence loss" is not a requirement. Our profligate fiscal policies could hardly be worse, but what makes the world tolerate our economic policies is the necessity to hold dollars in order to purchase oil.

Shameless "geopolitical buffing" was typed, then removed. I haven't had coffee yet.
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