A Theory About The Dollar

Mark Haines asked an interesting question about the dollar to economist Bob Barbera. If the US is in better economic shape than Europe, why is the dollar weaker against the euro? This ties into something I wrote a couple of months ago that I think is worth revisiting.

There is visibility for major changes in the way the world uses the dollar. If any or all of those changes come to fruition the euro would likely be the beneficiary. When the euro first traded it was thought that it might supplant the dollar as the world reserve currency. That hasn't happened...yet. I don't know if it will or will not happen.

There is visibility for some sort of switch to the euro. Months ago Russia expressed an interest in buying euros with its petro dollars. Earlier this week there was the news from South Korea that was not as bad as first feared, but no should be surprised if large holders of US debt look to buy euro denominated debt in the future. Over the next couple of years there will probably be chatter about denominating things like gold, oil and copper in something other than dollars, probably euros.

I have heard that there are not enough euros in existence to begin to accommodate these types of things. Euroland is getting bigger, taking in more countries. This offsets a portion of that argument. Also I do not think that changes will necessarily be all or none. That places like India and Taiwan (both very large holders of our debt) may diversify a little with future investments is not much of a stretch.

Eastern Europe offers a high growth element to the continent that the US does not have. Countries like Turkey, Poland and the Czech Republic will eventually contribute to Europe's growth.

For any of this to hold water would mean that the currency market is looking to the future and seeing that things may be different. The changes that might happen are not detrimental to the euro and my thinking is that potential demand for euros is more important, for the time being, than the current state of the economy.