The euro and the dollar have reached parity for the first time in two decades, a situation last seen in November 2002. This near one-to-one exchange rate is a significant economic event, though it doesn’t fully represent the euro’s inherent value relative to the dollar. The current parity is largely driven by the dollar’s appreciation, rather than a fundamental weakening of the euro. The differing monetary policy cycles between the United States and the Eurozone are key factors, with the US raising interest rates more aggressively, thus strengthening the dollar.
While the nominal Euro To Dollar exchange rate has fallen to these notably low levels, it’s important to consider the effective exchange rate. This measure, which reflects competitiveness, hasn’t seen a dramatic decline. In fact, current levels are only slightly below a stable trend that has been in place since before the 2008 financial crisis. This suggests that the Eurozone’s competitive position hasn’t structurally deteriorated. However, this stability is not guaranteed and hinges on how the European Union’s rapid shift away from Russian energy impacts its economy in the coming months.
Economists have a complex view of currency depreciation. A weaker currency can boost exports by making them cheaper for international buyers, potentially opening up new markets. However, ongoing disruptions in global supply chains, stemming from the pandemic, limit exporters’ ability to fully capitalize on these lower prices. Conversely, a cheaper euro can also signal economic weakness and fuel inflation by making imports more expensive. The overall impact depends on the balance between these positive and negative effects.
Beyond the psychological impact of euro to dollar parity, there’s another concern for the Eurozone. It potentially undermines the ambition for the euro to become a significant global currency alongside the dollar.
The war in Ukraine has amplified the geopolitical importance of finance and even weaponized it. From freezing Russian assets to Russia’s demands for gas payments in rubles, currencies have become strategic tools. Increased global use of the euro would enhance the EU’s ability to influence international terms and conditions. Furthermore, with all euro transactions processed through its own settlement system, the EU could more effectively impose financial sanctions and freeze assets held by adversaries.
The Eurozone economy accounts for about 15% of global GDP, while the US represents approximately 25%. The US financial system is roughly twice the size of the Eurozone’s. The US has around $20 trillion in outstanding debt rated as high quality, compared to about $10 trillion for Eurozone countries, with only $2 trillion of that being top-rated. The EU’s Recovery and Resilience Fund, created in response to the pandemic, will add €750 billion in high-quality debt, but this is still significantly less than the volume of US assets available worldwide.
These factors contribute to the US dollar’s continued dominance as the leading international currency. Approximately 60% of global foreign reserves are held in dollars, compared to only 20% in euros. China, with an economy and financial system comparable in size to the EU but a less internationally traded currency, presents a potential challenge. However, with a population of 1.4 billion and higher growth rates than both the EU and US, China has the potential to eventually challenge the dollar’s supremacy.
The crucial question for Europe is how to implement policies that promote the euro’s global use. A currency’s relative value is an outcome of economic conditions, not a policy target in itself. Artificially propping up the euro is unsustainable and undesirable. Instead, a strong and resilient Eurozone economy is the foundation for a strong euro. Therefore, the focus should be on policies that strengthen the Eurozone economy.
There are various proposals on how to enhance the euro’s international role. However, external actors considering greater euro usage need confidence not just in individual Eurozone economies, but also in the stability and continued functionality of the Eurozone and EU institutions. Concerns arise when the monetary union’s structural weaknesses hinder effective policymaking. The current risk of financial fragmentation within the Eurozone is a prime example. This presents significant challenges for the European Central Bank in its efforts to maintain both financial and monetary stability.
Ultimately, the primary obstacle to the euro’s greater international prominence is the lingering uncertainty about its long-term stability. Until this fundamental issue is addressed, the dollar is likely to remain the dominant global currency.
