Will the Euro Dethrone the Dollar?

In April 2007, the euro’s exchange rate against the dollar reached an all-time high, and central banks have increased the euro share of their international reserves. But while the euro has clearly made some headway during the current period of US balance of payment deficits, this reflects an evolutionary decline in the dollar’s dominance, not a revolutionary regime shift.

Much of America’s dominance in world finance comes from the dollar’s status as international money. America’s commitment to free capital markets, the rule of law, and price stability confer credibility on the dollar as a store of value. But American spending habits have undermined the dollar’s reputation, with the excess supply of dollars on world markets depressing its price. This spring, the euro’s exchange rate against the dollar reached an all-time high, and central banks have increased the euro share of their international reserves. Is the dollar about to lose the crown of world finance to the euro?

History suggests otherwise, despite a vulnerable dollar.

American financial supremacy in the twenty-first century resembles Britain’s position in world finance a century ago. Before the outbreak of World War I in August 1914, the pound sterling served as the currency of choice for international transactions, just as the dollar does today, and the world’s borrowers visited the City of London to raise capital.

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