Could the Euro Replace the Dollar as the World's Reserve Currency?

The U.S. dollar remains the world's reserve currency (for now), with central banks holding 2/3rds of their reserves in dollars. But, according to recent news, the dollar's status as the world's reserve currency is changing. The dollar is being challenged by the euro, which is now five years old.

For the first time ever, the value of all euro notes in circulation exceeded the value of all dollars in circulation. The total dollar value of all euros in circulation (at the end of 2006) was $828 billion, compared to $753 billion worth of dollars.

Even more ominous is the fact that many countries are diversifying away from dollars into euros (or threatening to do so).

• Russia has threatened to price its huge oil and gas exports in euros instead of dollars as part of a strategic shift to forge closer ties with the European Union, and to hedge against the falling dollar. Russia is the world's second largest oil exporter.
• Sweden has cut its dollar holdings, from 37 percent of central bank reserves to 20 percent, with the euro's share rising to 50 percent.
• UAE Converts Dollars to Euros – The declining U.S. dollar has caused the United Arab Emirates, a close U.S. ally, to convert eight percent of its $25 billion foreign exchange reserves into euros. Kuwait and Qatar have indicated that they plan to make similar moves.
• Other countries, including Russia, Venezuela, Indonesia and Iran also have decided to cut their dollar reserves or, in Iran's case, start pricing oil in euros. Iraq has priced its oil in euros since 2000.

Fred Bergsten, director of The Peterson Institute for International Economics, predicts that within 5 to 10 years, half of all global finance could be conducted in euros…

The euro is the first currency in 100 years that can really compete with the dollar on a global level. The U.S. dollar has been the dominant currency because it's had no competition. The creation of the euro changes all that.”

The U.S. is the world's largest net debtor, and the world's largest net borrower. What is not commonly known is that the main financiers of the U.S. deficits are not U.S. allies such as Japan and Europe, but rather competitors such as China, Russia, and Middle East nations. In fact, China holds 20 percent of all foreign reserves (roughly $1 trillion), which could create a sticky political situation, given China's growing economic power and its status as a massive exporter.