From the Gulf Daily News
Bahrain
Sunday, August 7, 2005
http://www.gulf-daily-news.com/Story.asp? [1]
Article=118774&Sn=BUSI&IssueID=28140
WASHINGTON -- 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 US 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 centre.
Second is the role of US 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 US
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 US current account deficit has ballooned in recent years to
about 6pc of GDP and its outstanding stock of debts to the rest of
the world has risen to 20pc 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 64pc of the $3.81 trillion of world
currency reserves are held in dollars and 20pc 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 per cent from 30pc and cut the dollar
proportion to 65pc from 70pc.
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