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A rising euro threatens American dominance

As the dollar continues its relentless six-year slide against the euro and other main currencies, the question is being asked more and more: what would it mean if the dollar ceded its global dominance to the euro?

The question is a serious one because the US Federal Reserve is pumping new dollars into the global economy at an astounding pace. (...) we are living witnesses to Milton Friedman's famous dictum that "inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output".

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The dollar is looking more and more like a typical developing country's currency, with long-term market interest rates, crucial to determining borrowing and investment behaviour, climbing as the Fed pushes hard in the other direction.

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 In a financial crisis, central banks are supposed to act as "lenders of last resort", printing money to prop up banks and reassure their depositors. This does not work in developing countries. People withdraw money anyway, not because they fear the governments will let the banks collapse but because they fear the inflation and depreciation that printing money brings. So they exchange it for dollars, undermining the putative powers of their central banks. But what if Americans were to do the same, selling dollars for euros in a crisis? The Fed would become impotent. This is not science fiction. American investors have lately been pouring money into foreign bond funds at a record rate.

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The US has exploited the unique role of the dollar in international trade and investment to disrupt the financial flows of its adversaries, such as North Korea and Iran. If such transactions switched to euros and were funnelled through institutions not doing business in the US, this power would be neutered. The US would likewise lose influence over both friends and enemies facing financial problems, as they would be looking increasingly to Europe for euros, rather than to America for dollars.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Apr 30th, 2008 at 10:01:02 AM EST

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