April 23, 2008

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Why the euro will soon replace the dollar as the world's reserve currency We know the credit crisis is a clear and present threat to the global economy. But its most important long-run legacy may not be economic, but geopolitical. I was reminded of that possibility when reading a recent analysis by Professors Menzie Chinn at the University of Wisconsin and Jeffrey Frankel of Harvard*. They ran a simulation showing that the euro would replace the dollar as the world’s largest reserve currency within the next 10 or 15 years. Their analysis is not based on this crisis. But the crisis could easily accelerate the trends they have identified. Do not dismiss this research as some anti-dollar propaganda. Professors Chinn and Frankel started with the opposite notion – that the euro would not overtake the dollar for a long time. After all, the world does not change reserve currencies very often. Sterling held pole position until the second world war, but lost it because of the UK’s imperial overreach. The US economy had already overtaken that of the UK in the 1870s. One of the factors that delayed the dollar’s rise was lack of a sophisticated financial sector, which did not develop until the establishment of the Federal Reserve System in 1913. Global reserve currency status is due to many factors such as the size of the economy, the country’s share in international trade and the depth of the financial markets. Inertia is another. If yours is a global reserve currency today, it is likely to be one tomorrow too. But this works only up to a point – a tipping point.

Watchman

I'm a watchman for Christ, looking on the horizon in expectation for the fulfillment of God's Word.

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