Install

Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

The Eye-Glazing Euro




Eleven European nations unveiled a new common currency on Friday, and millions of American eyes glazed over at the thought.


"Whatever it is, it has absolutely no effect on me," a typically bored worker at a Times Square delicatessen told a Wall Street Journal reporter who asked him about the euro. Duller than utility deregulation, as incomprehensible as Whitewater, more important than the North American Free Trade Agreement, the dawn of the euro is the great journalistic nightmare of our time. Not even media mogul Rupert Murdoch can get a catchy headline out of this story: "Eleven European Nations Move Cautiously Toward Currency Union." It's no "Ford to City: Drop Dead."


For at least two more years, the euro will only be a unit of account, a kind of virtual money that exists only in computers.


There won't be any euro coins or bank notes; euros won't be used in stores. Even in 2001, when euro notes and coins appear, most Americans figure that euros will be like the metric system or the French: annoying, foreign and tricky, but something you have to deal with only abroad.


Don't be fooled. This meek and mild-mannered Clark Kent of a story is really the Superman of financial news. At best, it could unleash a new period of prosperity and growth in Europe that could propel the world economy to new highs in the next century; at worst, it could threaten world peace.


For the first time since World War II, there will be a money that can potentially challenge the dollar's role as the world's major currency. The United States has been lucky since World War II. Demand for the dollar has stayed high because corporations, governments, banks and private citizens abroad have chosen to keep large portions of their assets in dollars, or in dollar-denominated assets such as U.S. stocks and bonds. Take the extreme example of Russia: Millions of Russians are keeping billions of dollars under their mattresses because they don't trust either Russian rubles or Russian banks.


When foreigners hold their savings in dollars, it is as if the people you wrote checks to didn't cash them but kept them stored safely away. If that happened, you could write a lot more checks than you had money in the bank, and nobody would care.


In essence, that is what the United States has been able to do since World War II: write checks that we knew would never be cashed because foreign governments and private citizens wanted to hold onto our IOUs. This is how the United States has been able to afford such large trade deficits and government budget deficits with so little pain: Foreigners have been willing to hold large dollar balances.


The euro may end that happy state of affairs. Up until Dec. 31, 1998, there were no good alternatives to the dollar for foreigners who wanted to shelter assets. For a central bank with hundreds of billions of dollars worth of assets, there haven't been many good alternatives to U.S. debt markets. If you need to sell $10 billion of U.S. Treasury bonds, the market is so big your sell orders won't send it into a panic. A comparable order to sell, say, Danish government securities, could swamp the market.


But when you add the debt markets of the 11 euro countries - Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain - you have a capital market as deep as that of the United States. The euro, therefore, gives many organizations their first realistic alternative to the dollar for very large portfolios. The Bank of China already is planning to decrease its dollar holdings from 62 percent of its portfolio to 50 percent, while increasing its weighting both in the yen and the euro. As big investors abandon dollars, the price of the dollar compared to other currencies might fall, leading more people to shift money out of the dollar, depressing its value still farther. Once the euro is in place, preventing a dollar freefall will become a long-term concern for U.S. policy-makers.


There's another problem. Since World War II, the Federal Reserve of the United States has been, in effect, the central bank of the world. Federal Reserve Board Chairman Alan Greenspan dramatically demonstrated how that works last fall, when he cut interest rates three times to stop what otherwise might have turned into a 1930s-style global depression.


With the rise of the euro, Greenspan and his successors won't have as much freedom to act decisively. In the future, if the Fed cuts rates to fight global recession, many investors will shift out of the dollar into the euro, depressing the dollar and contributing to inflation in the United States. That won't be good news for Europeans - or anybody else.


One hopes the newly powerful European central bankers running the euro will work cooperatively with the Fed to keep the world economy strong.


But there is no guarantee. Historically, some of the most dangerous financial panics have occurred when a new monetary power has become strong, but has not yet learned through experience that it cannot neglect its global responsibilities. Both the Bank of England in the 19th century and the Fed in the 1920s and '30s put the world through some difficult moments as they learned to balance domestic and international responsibilities.


Walter Russell Mead, a senior fellow at the Council on Foreign Relations, is the author of "Mortal Splendor: The American Empire in Transition." He contributed this comment to the Los Angeles Times.