Stronger Euro: Is It Worth?

In 1999, Hans Eichel, former Germany's finance minister said "The euro could become a reserve currency with equal status to the dollar". However, no one suspected this could happen as early as 2007. In fact, last week the euro traded close to $1.50 on rumors that central banks were replacing some of their U.S. dollar reserves with euros.

Since 1999, when the euro was officially launched, the single currency gained more than 28 percent against U.S. dollar.  More specifically, since its lowest level in October 2000 the euro gained nearly 76 percent and during the last three months it appreciated almost 10 percent against dollar. It is widely known that the euro has already overtaken the dollar as the main denomination of international debt issues and the value of euro notes in circulation is bigger than the value of dollar bills. Moreover, between early 2002 and the second quarter of this year, the euro's share of known official foreign exchange reserves rose from 19.7 per cent to an impressive 25.6 per cent, according to International Monetary Fund. How much the reserves changed since the beginning of credit crunch in August and by how much they will change during the next few years are two questions which answers are likely to dictate the future EURUSD exchange rate.

So, why the euro is so strong? One of the reasons why the euro is so strong is obviously the U.S. dollar weakness. However, the recent turmoil in the U.S. economy doesn’t completely explain the strength of the EURUSD. The Euro Area economy looks much better than it did a few years ago. As a result, international investors are more willing to hedge dollar exposure with investments into the Eurozone.

But is it worth to have a strong Euro? There is no doubt that if the euro becomes the world’s reserve currency, the European economy, in particular the euro area inflation will be less vulnerable to shifts in exchange rates. The Euro Area would also benefit from low interest rates on loans in the form of large central bank holdings of euros. On the other hand, the internationalization could complicate the control of the single currency in circulation and potentially generate inflation. Also, an increase in the demand for euros may cause the currency to appreciate and make exports less competitive. A strong euro may as well become a source of conflict within Euro Area since some of its members run a big current account deficit and their growth depends on exports.

Anna Fedec,
11/30/2007 6:43:52 PM