Euro gives dollar a run for the money
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A new BIS working paper by economists Gabriele Galati and Philip Wooldridge concludes: "The liquidity and breadth of euro financial markets are fast approaching those of dollar markets, and as a result the euro is eroding some of the advantages that have historically supported the preeminence of the US dollar as a reserve currency."Skip to next paragraph
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Nevertheless, the dollar has maintained its place as the dominant official reserve holding of central banks. Public data on such holdings is often incomplete and secret. But the BIS paper estimates that the share of euro- denominated reserves has risen to 25 percent in 2005-06, up from 20 to 22 percent in 1995-96 for the currencies of the nations that subsequently joined the euro system.
Foreign central bankers hold dollar assets in their reserves because they can be sold easily in emergencies to defend the value of their own currencies on foreign-exchange markets. The market for dollar assets in the world's financial system is huge. Bankers aren't so troubled about whether those assets (usually short-term US Treasuries) lose value in terms of their own currencies. Finance ministries, with their political concerns, may see declining dollar assets with more distaste.
Overall, however, the US dollar lost only about 4.5 percent in value last year against a basket of foreign currencies selected and weighted by the value of US imports and exports.
Since the end of what is known as the Bretton Woods international monetary system under President Nixon, the value of the dollar on foreign-exchange markets has fluctuated. But according to one expert, the dollar's purchasing power, compared with other currencies, has changed little since 1971.
The US is the world's largest debtor nation. So when the dollar depreciates, foreigners see the value of their dollar assets decline in terms of their own currencies. They continue to be paid interest on those American debts, but they are "robbed" of some of their value, should they sell them.
Such losses worldwide could total many billions of dollars. China alone holds more than $700 billion in its reserves. A 10 percent drop in the value of the dollar against the yuan would mean a $70 billion loss for China.
The US benefits when foreigners use the dollar because Washington gets first use of that money, and after production costs, it's free, called seigniorage.
In an ideal world, says John Williamson, a veteran economist at the Peterson Institute for International Economics in Washington, there would be one international reserve currency rather than a national currency, such as the dollar, acting as an international reserve currency.
"It's not healthy for one country to have a monopoly," he says.
But Special Drawing Rights, a currency system created by the International Monetary Fund in 1969 as a substitute for the dollar and for gold, have not caught on among central bankers. They have merely a minor role in world finance today.
As for the future of the dollar, the view of economists differs.
Commerzbank's Mr. Pietsch, though seeing the euro as a continuing competitor to the dollar, expects its value to slip to $1.27 by the end of the year.
Peter Morici, an economist at the University of Maryland, College Park, maintains that the relative vitality and innovation of the American economy will limit the challenge from the euro. "The world still revolves around the US economy," he says.