With the dollar seemingly in terminal decline, there is little stopping the euro from becoming the world’s premier reserve currency, argues Wolfgang Münchau in a March commentary for EuroIntelligence.
Münchau bases his hypothesis on a study by two professors, Chinn and Frankel, based at the Universities of Wisconsin and Harvard respectively. Their study concludes that the euro will overtake the dollar within the next 10-15 years.
The author points to the fact that sterling held the position of reserve currency until the Second World War, but lost it due to imperial overreach. This, he warns, could happen to the dollar for a variety of reasons, perhaps including multiple US interventions abroad.
Continual budget deficits under the Bush Administration and the emergence of an indisputable alternative currency are also pressing reasons for the international deterioration of the dollar, Münchau argues. The US Federal Reserve, he claims, has further accelerated the dollar’s decline by following a “reckless monetary policy,” which could cause a rise in US inflation once the current recession ends.
This weakness of the US financial sector will play into the hands of the Europeans, whose economies are better suited to overcoming the current credit crisis, the author believes. However, despite gloomy predictions for the dollar, the euro is not in a position to overtake it at the moment, he argues, pointing out that the euro holds one-third of global reserves compared to the dollar’s two-thirds.
Nevertheless, says Münchau, the wheels are in motion and the implications of such a change are huge. The US will lose the privilege of gaining higher returns on foreign assets than the return paid to foreign investors in the US, he predicts. This is not a loss of political power, but a simple loss of power, he states.
Politicians cannot control such massive global financial changes and lawmakers on Capitol Hill do not understand what is about to happen, claims Münchau.
But Europe has yet to prove that it can shoulder the responsibility of handling the world’s primary currency, he concludes.