Promoted at its advent as the currency that would topple the US dollar as the international reserve currency of choice, the euro is likely to struggle to achieve that goal in the wake of France’s rejection of the new EU constitution last week.
With the Netherlands likely to also vote against the proposed constitution on June 1, the dollar may be left to reign supreme for the foreseeable future, analysts said.
“There simply is no alternative currency that could fulfill the same role in the international financial system,” said Michael Woolfolk, senior currency strategist at Bank of New York in New York.
“The euro remains a work in progress, and is not yet ready to be a major reserve currency, let alone the international reserve currency.”
The proposed constitution was intended to make Europe more efficient and democratic. Its key measures included abolishing national governments’ vetoes over EU policies in many areas to speed decision making. It would also have created a full-time EU president and foreign minister to strengthen the EU’s global influence.
Existing treaties will enable the EU to continue as a political institution and free market zone, but economic reforms to spur European growth are seen being delayed as a result of this week’s referendums in France and Holland.
As a result, the stability of the US political and financial system is seen continuing to support the dollar’s role as the world’s main currency for trade and investment.
“While some realignment in currency values is likely, the American economy is underpinned by a stable and strong political system, by financial institutions that are larger and stronger than those in other parts of the industrial world, and by profitable and highly competitive investment returns when adjusted for global risks,” said Henry Kaufman, of financial firm Henry Kaufman & Co. Inc. in New York, speaking at a commencement address delivered at Trinity College this month.
Widespread usage of the dollar as the currency in which international trade is priced is also seen as a guarantee of its status as the currency of choice for investments.
“The safety of the dollar’s reserve status rests partly on its ubiquity; the rest of the world holds too many dollars to risk throwing it overboard entirely,” said Chip Hanlon, president of Delta Global Advisors Inc. in Huntington Beach, California.
However, other analysts point to the lesson Britain learned when the pound was the world’s reserve currency for one hundred and fifty years until World War Two.
At the height of Britain’s imperial power world trade was conducted in pounds, and other governments tapped London’s more liquid capital markets and issued sterling-denominated debt.
However, two world wars strained Britain’s fiscal resources and the pound gradually lost its status, with the dollar assuming international reserve status as the anchor of the Bretton Woods global foreign exchange system from 1946.
History may repeat
Given the record US fiscal and current account deficits at present, the US dollar’s reserve status may not be impregnable, analysts warn. The dollar slid to its lowest levels in a decade in late 2004 before partially recovering in recent months.
The euro and dollar could yet exist side by side as international reserve currencies, given the euro zone is the only economy that rivals the United States and has markets as deep and as liquid, said economist Barry Eichengreen in a working paper for the National Bureau of Economic Research.
“Financial innovation will continue to reduce the cost of converting currencies, further reducing the incentive to hold reserves in the same form that other countries hold reserves simply in order to minimize transaction costs,” said Eichengreen, a professor at University of California, Berkeley. (Reuters)