What Happens if the Euro Falls? Will the Dollar Strengthen Further as the World’s Reserve Currency?

The Eurozone is faltering according to recent reports. Some of the weaker member-states are facing bleak economic conditions, weakening the confidence of stronger members in the Euro as a currency.

The formation of the Eurozone gave many in the international community hope that  the economies of Europe and government policies would become more homogeneous and productive. Additionally, weaker member states hoped a stronger currency would boost their domestic economies, eventually making the Eurozone a viable competitor to the United States. The global economic recession, however, has made many European countries rethink their pledge to circulate the Euro.

As a reminder, the United Kingdom never adopted the Euro. At the time  the Pound was estimated to be stronger than the Euro, and therefore too risky for the Brits to use as their own. This was a controversial decision during the formation of the Eurozone, but it has proven to be wise in the long  haul.

The World’s Reserve Currency is STILL the United States Dollar

According to Wikipedia’s World Reserve Currency entry, 62.1% of world reserves were in the United States dollar in 2011. The Euro came in a distant second at 24.9%.  The Pound Sterling and Japanese Yen come in around 4% a piece, with the Swiss Franc barely making the chart at 0.3%. This generally suggests most countries view the United States economy to be stable enough to invest in dollars, ie. buy Treasury Bonds or simply hold dollars in central banks. “Stable” is a relative term nowadays, and in reality the beleaguered USA economy is simply a safer bet compared to the desperate situation in the Eurozone.

What about the Chinese Yuan? Good question. As long as China continues to manipulate its currency value and NOT sell bonds on the open market, it doesn’t make sense for other central banks to invest in it.  The Chinese have quietly instituted some currency trade agreements with other nations, but not nearly enough to make it a global reserve contender. They’ve also wisely stockpiled currency for a rainy day. They might not play by the same rules, but they do protect their own self interests.

Go USA?!? Not quite

Many economists, both American and foreign, advocate for NOT using the United States dollar. Some believe central governments should hold a mix of many currencies, or a neutral currency (Bit Coin? 🙂 ) that does not necessarily favor one country over another.

For the meantime, however, it’s still a good thing that other governments, including China, choose to hold dollars. It gives them an incentive to allow the USA to succeed economically, with the secondary effect of producing a world favorable to USA political policies. After all, if your own bank account stands to benefit from a productive country, you’d probably like to see them succeed.

If the Euro does cease circulating, the strong member states in the Eurozone will be forced to circulate their own currency again. The weaker states (Greece, Ireland, Poland, etc.) would still have to pay their bills, in addition to adopting some form of legal tender. Stronger European countries have attempted to bailout other nations, but the results have not been positive since each country ultimately decides independently how the bailout money is spent,  and which austerity measures (if any) are implemented.

What’s next?

In the short run, if the Euro ceases to exist in the next 2-3 years, United States dollar reserves will go up, but so will the currencies of the surviving European nations, freed from the restraints of the Eurozone currency policies. They will immediately roll out their own fiscal and monetary policies, hoping to attract foreign investment as FAST as possible.

Unless the USA economy completely crumbles, it will still be a strong reserve currency even if another nation (China, Japan, Great Britain) takes over as the world’s leading reserve currency. The Euro is still strong despite its troubles, and rather than flush it down the toilet completely, Euro holders are keeping it with the hope that things will improve.

As with any investment, don’t gamble with money you can’t afford to lose!