The US dollar has been the world’s dominant reserve currency since World War II. It currently underpins a significant portion of global finance, representing 58 percent of foreign reserve holdings worldwide. In comparison, the euro, the second most utilized currency, accounts for only 20 percent of global foreign reserve holdings. This substantial gap underscores the dollar’s entrenched position, yet recent geopolitical events and economic shifts are prompting discussions about the future balance between the euro and the dollar in the international financial system.
The Enduring Strength of the Dollar and the Euro’s Position
Despite ongoing discussions about dedollarization and the rise of alternative financial systems, the dollar’s role as the primary global reserve currency remains robust. It continues to be the dominant currency in foreign reserve holdings, the invoicing of international trade, and global currency transactions. While there has been a modest long-term decline in the dollar’s share of global reserves, these losses have been distributed across a range of other currencies, rather than consolidating behind a single challenger. The euro, while the most significant alternative, has not been able to substantially close the gap with the dollar in overall global usage.
US dollar bills and wheat stalks symbolizing global trade and economic power
The euro’s capacity to challenge the dollar in the near to medium term is limited by several factors. These include the structural complexities of the Eurozone economy, the lack of a unified Eurozone fiscal policy, and the historical inertia of dollar dominance. While the euro benefits from the Eurozone’s large economy and significant trade flows, it lacks the depth and liquidity in financial markets that the US dollar enjoys. Furthermore, the US dollar benefits from a network effect – its widespread use reinforces its dominance, making it the preferred currency for many international transactions and reserve holdings.
Factors Influencing the Euro to Dollar Landscape
Recent efforts by BRICS nations to promote the use of domestic currencies and create alternative financial infrastructures are reshaping the global currency landscape, indirectly influencing the euro to dollar dynamic. At the 2024 BRICS Summit, key initiatives were endorsed to facilitate trade and finance in currencies other than the dollar. These initiatives, while not explicitly targeting the euro, aim to create a multipolar global currency system where reliance on the US dollar is reduced.
China’s Cross-Border Interbank Payment System (CIPS), Russia’s System for Transfer of Financial Messages (SPFS), and projects like mBridge represent concrete steps towards building alternatives to the SWIFT system and dollar-dominated payment networks. CIPS, in particular, has seen significant growth, connecting over 160 countries and processing a growing volume of transactions. These systems, while still nascent compared to established dollar-based infrastructure, offer avenues for countries to reduce their dependence on the dollar and potentially increase the use of other currencies, including the euro, in international trade.
Geopolitical tensions and the use of financial sanctions have also become crucial factors. The increased use of sanctions by the US and its allies has prompted some nations to seek alternatives to the dollar to mitigate risks. While this “dedollarization” trend is often discussed in the context of challenging US hegemony, it also creates opportunities for other currencies, such as the euro, to play a larger international role. However, it is important to note that the euro itself is also subject to geopolitical considerations and the influence of European Union policies.
What Makes a Reserve Currency? Comparing the Euro and Dollar
The qualities of a reserve currency are multifaceted, encompassing more than just economic size. Analyzing both the euro and the dollar against key criteria reveals why the dollar maintains its lead while also highlighting the euro’s strengths. Essential qualities include:
- Size of the economy: Both the US and Eurozone economies are large, supporting their respective currencies.
- Depth and liquidity of financial markets: The US dollar markets are significantly deeper and more liquid than Eurozone markets.
- Currency convertibility and stability: Both currencies are highly convertible and generally stable, although both can experience fluctuations.
- Confidence in the issuing authority: Both the US Federal Reserve and the European Central Bank are generally viewed as credible institutions.
- Network effects: The dollar benefits significantly from established global networks. The euro network is growing but still less extensive.
- Political stability and rule of law: Both the US and Eurozone generally offer political stability and strong rule of law, though perceptions can vary.
While the euro scores well on many of these criteria, particularly economic size and stability, it lags behind the dollar in market depth and established network effects. Furthermore, the political and economic fragmentation within the Eurozone can sometimes undermine confidence in the euro compared to the more unified structure of the United States.
The Future of Euro and Dollar in a Multipolar World
The global financial system is likely moving towards a more multipolar configuration, with a reduced but still central role for the US dollar. The euro is positioned to be a significant beneficiary of this shift, potentially increasing its share of global reserves and transactions. However, it is unlikely to displace the dollar as the dominant currency in the foreseeable future.
The future “euro to dollar” landscape will be shaped by a complex interplay of factors: the pace of dedollarization efforts, the evolution of alternative financial infrastructures, geopolitical dynamics, and the relative economic performance of the US and the Eurozone. While the dollar’s dominance is unlikely to be overturned, the euro’s role as a crucial pillar of the international monetary system is set to endure and potentially expand in a more multipolar world.
(References/Acknowledgements)
Research and analysis based on data and insights from Atlantic Council’s GeoEconomics Center research on dollar dominance. For further information, please refer to the original article “Dollar Dominance Monitor” by Atlantic Council.
