Dollar's dominance challenged

As the new head of the G8 and G20, French President Nicolas Sarkozy has launched his long-anticipated campaign to challenge the U.S. dollar's dominance as a reserve currency, a goal that economists doubt is within the powers of a single politician but nevertheless raises an important issue for the international monetary system.

Sarkozy took a running start in his first few weeks as head of G8, in which the richest countries of the world are represented, speaking publicly and in meetings with other leaders throughout the first weeks of January about his goals to diversify reserve currencies and balance the value of world currencies to allow for fairer competition among global economies.

Though economists and some world leaders have said Sarkozy's urgency on these matters may not be justified, his program could be good news for economies like the Czech Republic's, where foreign trade is mostly based in the eurozone. Allowing the value of the euro against the U.S. dollar to ease would boost neighboring European economies and, in the long term, allow the euro to take a stronger role as a reserve currency and improve various aspects of trade.

Currency values have grabbed attention in recent months because of a so-called "currency war" between the United States, the European Union and China. European leaders have criticized quantitative easing measures in the United States that make U.S. exports cheaper on the international market.

Still, some world leaders and analysts have questioned whether Sarkozy's war against the dollar should be a priority.

"It suggests that the U.S. policy has enabled the United States to pursue policies that were destabilizing to the EU economies, and so this would impose discipline on the Americans," said Simon Tilford, chief economist at the Centre for European Reform. "It's misleading about the underlying causes for the crisis. ... It's hard to see how this will have a major impact on helping solve problems."

Sarkozy has been vocal about the importance of reducing the U.S. dollar's dominance for years and has said that the dollar's prominence as a reserve currency contributed to the financial crisis because instability in U.S. markets influenced economies around the world.

The dollar has been the world's dominant reserve currency since the end of World War II. As the major reserve currency, the U.S. dollar is most widely used by countries to pay off international debt. Also, U.S. companies maintain an advantage in international trade, because they incur no transaction fees for exchanging currency.

If the euro were to take a more dominant role as a reserve currency, those advantages could be enjoyed by more European countries, and an economy like the Czech Republic's would undoubtedly benefit.

"One very important and interesting implication is that one of the aims of the reform is to help emerging economies shield themselves from capital inflows," said Zsolt Darvas, a research fellow at the Brussels-based think tank Bruegel. "During the crisis, there were some ad hoc solutions like swap [agreements] that were not offered to countries like the Czech Republic and Hungary. If the EU has greater dominance, the European Central Bank may have a brighter regional responsibility."

Swap agreements are financial transactions in which two parties change financial instruments for an agreed amount of time. In the case of currency, countries exchange aspects of a loan, like the principal or interest payments, in one currency for the equal value of the same aspects in another currency. This is done to secure cheaper debt and reduce exposure to exchange-rate fluctuations.

Nevertheless, economists say the difference would likely be negligible, as the euro already holds a fairly dominant role as a reserve currency. The most prominent benefits, they say, would come with a switch to using the euro, which is still a very hard sell as members of the Czech National Bank and the current administration have made it very clear they have no intention of making that switch anytime soon.

"I don't think anyone should overstate the significance of this. Over time it will happen, and it will have some benefits," Tilford said, adding it would be one reason for the country to switch to the euro, but that it wouldn't be a "game changer."

Cat Contiguglia can be reached at
ccontiguglia@praguepost.com