Euro Could Replace Dollar

Two American economists recently conducted a computer simulation to determine how the role of the US Dollar as the world's reserve currency will evolve over the next decade. Their hypothesis- that the Dollar's preeminence would be maintained- was contradicted by the simulation leading them to conclude that the Euro will overtake the Dollar within the next 10-15 years. This may be hard for many analysts to stomach, since the Dollar's share in global currency reserves is 66%, compared to the Euro's 25%. In addition, the Dollar has held its title for nearly 150 years, and it's difficult to fathom its being replaced.

However, two factors have emerged within the last 10 years, lending support to the argument. First, the US twin deficits have exploded; the current account deficit approximates $800 Billion and the national debt is estimated at $9.4 Trillion. Second, prior to the inception of the Euro, there didn't exist a credible alternative to the Dollar. The Deutsch Mark and Japanese Yen initially seemed like potential candidates, but the German currency was folded into the Euro, and the Japanese economy has soured and taken over by deflation. Then there are peripheral factors, like US monetary policy, which is facilitating inflation and eroding the Dollar. There are also signs that a neo-imperialist foreign policy has overstretched the US, and foreign Central Banks are becoming nervous. The Financial Times reports:

Many developing countries will find it harder to maintain their dollar pegs. They may be reluctant to drop them now but there will come a point when the rise in inflationary pressures becomes unbearable.

Loonie in Trouble

In a recent article published in the Toronto Star, a Canadian columnist outlined five reasons why the Canadian economy is in trouble. Only a couple factors are unique to Canada, and several can be subsumed under the credit crunch, but the pessimists are sounding broad alarm bells. First on the list is the looming drop in prices for commodities, the cornerstone of Canada's economy. Oil recently sank below $100/barrel, and gold dropped 5% in one day! In addition, China is threatening to curb demand in order to rein in inflation.

The second and third causes for concern are a decline in bank credit and loss of confidence, respectively. Neither of these factors are endemic to Canada, as banks around the world have suddenly developed an aversion to risk and have tightened lending accordingly. Next, corporate expansion (namely of American companies) is stalling; Home Depot and Proctor & Gamble have already announced a temporary hold on opening new stores in Canada. The final factor(s) are American consumers, which collectively spend $9 Trillion per year. The recent tightening of wallets could spell massive trouble for Canada, since some of its provincial economies are primarily driven by cross-border sales to Americans.

In short, the Canadian economy could actually contract in 2008. But perhaps the resulting decline in Canada's currency, the loonie, would make Canadian exports comparatively more attractive and return the economy to firm footing in 2009.