My friend Barry Eichengreen, together with Marc Flandreau, has written a column in today’s Financial Times, that appears under the headline “Why the euro is unlikely to eclipse the dollar.” The body of the article is a claim that network externalities and tipping points are not important, or perhaps that they once were but no longer are.

The first two steps of their argument are:
(1) a multiple-currency system is the historical norm. The dollar-denominated system that we have experienced for more than 60 years is an aberration, so network externalities (aren’t) important.
(2) The dollar surpassed the pound in the 1924-25, not in 1948, so lags and tipping phenomena are not important.

Regarding (1), I have always thought that Barry has a good point that a multiple-currency system has one advantage, that it gives the lead currency some competition, which discourages it from abusing its position by excessive deficits, money creation, inflation and depreciation. But I disagree that network externalities are not also important: there will always be an advantage to having a lead currency internationally, just as there is an advantage to having a single money within each country.

Regarding (2), I have no problem dating the pound’s loss of supremacy from the 1920s, if that’s what the eminent economic historians say. But I don’t see how this affects any of the arguments. For one thing, the US surpassed the UK in economic size in 1872, and in exports in 1915. So there is still a lag of between 10 and 53 years.

More importantly, these propositions have no bearing on the central claim that Menzie Chinn and I have made: based on our statistically estimated effects of economic fundamentals, such as the size of euroland — which has recently passed the US economy — the euro now has the potential to rival or even displace the dollar as lead currency. We think we have also found statistical evidence of inertia and non-linearity, which imply a tipping point. But this doesn’t really matter. The scenario that we most emphasize leaves the dollar with an estimated share of central bank reserves only a little less than that of the euro even in the long run. Regardless what one believes about how fast it will occur or how complete the de-throning will be, our claim that the euro will challenge the dollar stands.

Question from The International Economy Survey of Experts: 
Ten years from now, which will likely be the next great global currency?

My answer: 
Contrary to fevered popular speculation in the 1990s, the yen and the mark never had the potential to challenge the dollar as premier international currency:  their home economies were smaller than the US and their financial markets less well developed and liquid than New York.   The euro, however, is a credible challenger:  Euroland is roughly as big as the United States.  Indeed, evaluated at the most recent exchange rates, the euro economy has just now surpassed the US economy in size.   Also the euro has shown itself a better store of value than the dollar.   These are two of the most important determinants of international reserve currency status.

To be sure, rankings of international currencies change only very slowly.    Although the US surpassed the UK in economic size in 1872, in exports in 1915, and as a net creditor in 1917, the dollar did not surpass the pound as number one international currency until 1945.   In 2005, when Menzie Chinn and I used historical data on central bank holdings of foreign exchange reserves to estimate the determinants, even our pessimistic scenarios did not have the euro overtaking the dollar until 2022.   Thus we could not have asserted that the dollar would be dethroned “ten years from now.”  But the dollar has continued to lose ground.    We have now updated our calculations, particularly to recognize that London is usurping Frankfurt’s role as the financial capital of the euro, notwithstanding that the UK remains outside of EMU.   It is also relevant that — at the most recent exchange rates — the GDP of euroland has surpassed that of the US.   Now we find that the tipping point could come within the ten-year horizon: the euro could overtake the dollar even as early as 2015.

Simulation of central banks’ reserve holdings: € passes $ around 2015 .
Scenario: Only accession countries join EMU in 2010 (UK stays out),
but 20% of London turnover counts toward Euro area financial depth,
and currencies depreciate at the 20-year rates experienced up to 2007.
Source: Chinn and Frankel (2008, Figure 7).