South-Western College Publishing - Economics  
Euro-Phobia?
Subject Economic Growth
Topic International Finance
Key Words Currency Union, Exchange Rates, Economic Growth
News Story

Europe's new currency, the euro, is supposed to become the principal rival to the dollar. Although the euro had a positive debut, it is uncertain how it will fare against the dollar both this year and over time. The attitude on this side of the Atlantic has always been positive. The position of the Clinton administration has been that any measure that promotes trade and economic growth for America's trading partners is good for the United States. If the new currency is successful and does become a rival to the dollar, that position may very well change.

There are challenges both here and abroad. Europe's attention could focus on the euro and monetary union while ignoring a host of macroeconomic challenges such as high unemployment, excessive regulation, and meager job creation. The euro could, on the other hand, be the stimulus that leads the European nations to economic reforms that promote employment and growth. A senior American official summarized these possible outcomes by stating that if the euro is successful, Europe will emerge stronger and more prosperous. If the euro fails, Europe will become more divided, poorer, and less confident.

A successful euro could be of considerable benefit to the United States. By replacing eleven currencies with the euro, it should be easier and less expensive for American companies to export to Europe. Eliminating fluctuating exchange rates will stabilize and probably lower prices, which should also favor competitive American companies.

Alternatively, a successful euro could damage the U.S. economy. To the extent that the euro may rival the influence and financial power of the dollar, the U.S. Treasury may find it more difficult to sell its bonds. This would raise the cost of borrowing to the U.S. Because the dollar is the world's leading currency, the de facto national currency in many countries is the dollar. Dollars are held and exchanged much like in the U.S. This practice essentially provided the U.S. with interest-free loans. Europe appears to have recognized the potential role of the euro in devising its new currency.

(Updated February 1, 1999)

Questions
1. What determines the exchange rate between any two countries?
2. What is the cost of exchanging one currency for another currency?
3. Suppose that the euro becomes very popular at the expense of the dollar (that is, the dollar becomes less popular), what will happen to the exchange rate between the dollar and the euro?
Source Richard W. Stevenson, "The Euro: For U.S., Gains and Losses", The New York Times, January 4, 1999.

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