The Euro/Dollar Roller Coaster Ride

by Fred Cederholm

The good news is, the EURO isn't going to be replacing the dollar. The bad news is.....
I’ve been thinking about EUROs, reserve currencies, "M’s," the European Union, central banks, GDP’s, and debt instruments. Recently the US dollar took a valuation roller coaster ride against world currencies. The global financial press featured obituary/predictions on the future of the buck in the context of the recent discussions at Davos and the G7 Conference at Paris. But... not much has really happened--because it couldn’t.

A reserve currency is one held by other governments and institutions as part of their foreign exchange reserves. Such status is a mixed blessing. This not only signifies for US/us that nation/ states have confidence in our fiat currency (no real links to gold /silver since 1971); but also our Federal Reserve Notes signify an evergreen line of credit for the US of A--from decades of escalating trade imbalances. The EURO replacing the US dollar as "THE reserve currency" won’t happen because it just isn’t big enough--there are controlling legal/contractual authorities, and because it lacks the prerequisite financial "infrastructure." Don’t believe me? Read on.

Money supply is defined in terms of "M’s." The "US M1" refers to the printed currency and all deposits in checking accounts (demand deposits), and unredeemed/outstanding traveler’s checks. The "US M2" picks up M1 components plus all time-related deposits--savings accounts, small CD’s and non-institutional money market funds. The "US M3" picks up M2 components plus all large time deposits, institutional money market funds, and short-term repurchase agreements, along with Eurodollar holdings. As of December 31, 2004, there were 1.389 TRILLION in M1 $’s, 6.440 TRILLION in M2 $’s, and 9.457 TRILLION in M3 $’s on our books. While there are minor differences in their definitions of the "M’s," on that same date, there were 2.894 TRILLION in M1 EUROs, 5.565 TRILLION in M2 EUROs, and 6.529 TRILLION in M3 EUROs on their books. Superficially it appears they are comparable, but there is more to it than a huge money supply.

Although the European Central Bank makes the big monetary policy decisions, national central bank governors each share in the decision-making in its governing council. These central banks implement the decisions in their own countries--a critical difference from the monolithic organization of the US Federal Reserve under Chairman/Czar Greenspan.

Politically, economically, and financially; the European Union (EU) more resembles a loosely configured America under the Articles of Confederation than it does the United States under the US Constitution. That is a critical distinction. While the EU presently has 25 members, only 12 make up the Eurozone having the EURO as a common currency--a significant point.

The European Central Bank (ECB) coordinates the independent functioning of the respective 12 national central banks which each issue the "EURO currency" in accordance with founding formulae and agreements. Although the ECB makes the big monetary policy decisions, national central bank governors each share in the decision-making in its governing council. The national central banks implement the decisions in their own countries. This is a critical difference from the monolithic organization of the US Federal Reserve under Chairman/Czar Greenspan.

Gross Domestic Product (GDP) becomes another significant factor. The 25-member European Union has a combined 2004 GDP of $11.05 TRILLION compared to a 2004 GDP of $10.99 TRILLION for the US. While these levels seem so close as to be a non-issue, this is like comparing apple blossoms to apples--because it is only the GDP of the 12 member nations who issue and use the EURO as their currency that truly matter. To be able to issue EUROs, and thus be a part of the Eurozone, each issuer can have outstanding debt not to exceed 60% of its respective GDP. Their TRUE cap on debt instruments becomes very important, because we all know from past experience that a "ceiling" on debt for US/us is a joke. (The sky’s the limit?)

In accumulating such bodies of reserve currency through the ongoing imbalance of trade (exports exceeding imports), you want them to be earning assets--you expect "investments" to earn a rate of return while you hold them. Interest is the premium earned from converting your reserve currency into time deposits, or the debt instruments of that currency’s issuer. At 12-31-04, the amount owed to Social Security and other "trusts" was $3.188 TRILLION; and "publicly held debt" was $4.408 TRILLION--40 to 45% being held by foreign interests. You couldn’t convert that level of foreign holdings of US/us debt into additional Eurozone debt instruments--they can’t now exist!

Copyright 2005 Fred Cederholm. All rights reserved. Fred Cederholm is a CPA/CFE, a forensic accountant, and writer who contributes the column "TH*NK*NG" to The Weekly Observer in Creston, (Ogle County) Illinois. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.). He can be reached at

To "Audit" this column and to learn more about the EURO, the US Dollar, debt instruments, and reserve currencies, check out the following links:

Table 1--M1 M2 M3 money supply in billions of dollars

PDF format presentation of M1 M2 M3 money supply in Euros as of 12-31-04

Ranking of GDPs from the CIA factbook

An introduction to the European Union.

The Debt to the Penny and Who Holds It

Flow of Funds Accounts of the United States

Debt growth, borrowing and debt outstanding (tables in PDF) format most recent issued 12-09-04

A good FAQ presentation of Euro background from the UK perspective (Note: UK not in the Eurozone) There are numerous internal links to further explanations and information.

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This story was published on February 18, 2005.