By Paul Blustein
Washington Post Staff Writer
Friday, January 1, 1999

The beginning of the end for one of America's great free lunches comes today, when 11 European countries launch the euro as their common currency.

That's one scenario, based on some analysts' expectation that the euro's introduction will undermine the U.S. dollar's dominance in the global monetary system, threatening America's ability to maintain its profligate economy by borrowing cheaply from overseas.

But others offer another, less disturbing prediction of how the euro will affect the United States: It will do little harm to the U.S. economy, in this view, and may do considerable good. The dollar will retain its premier role in world finance and trade, while a more unified European market offers lucrative opportunities for American corporations and provides reassurance that the Continent will never again plunge into war.

Such conflicting forecasts are among the many maddening uncertainties surrounding Europe's grand experiment in creating a unified currency.

What nearly everyone agrees on is that the euro could pose the first serious challenge to the dollar's half-century reign as the undisputed king of global currencies.

The U.S. Treasury – the guardian of the dollar's international status – is blase» about the euro. Both publicly and privately, Clinton administration economists wish their European counterparts luck in establishing a credible currency that helps foster a more vibrant, stable economy on the Continent.

"We have everything to gain and little to lose from the success of this momentous project," Lawrence H. Summers, the deputy treasury secretary, said in a speech last month. "If Europe benefits, this will greatly benefit the United States."

A number of economists and money market experts are far less sanguine about the new currency's ramifications.

After all, the dollar commands a position in the world economy that far exceeds the United States' 27 percent share of global output. The greenback is used in more than half of all international trade and international borrowing, and it accounts for 57 percent of the reserves held by the world's central banks.

Such a disproportionately important role for the dollar could come into question with the creation of a single currency for "Euroland," the informal name given to the group of countries adopting the euro – Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. Euroland has a larger population than the United States and its gross domestic product is 77 percent of the United States'.

The euro is likely to be used instead of the dollar for much of the commerce within Euroland and between the bloc and its major trading partners, such as Britain, Brazil and South Africa.

"The euro's rise will convert an international monetary system that has been dominated by the dollar since World War II into a bipolar regime," predicted C. Fred Bergsten, director of the Institute for International Economics, in a 1997 article in Foreign Affairs magazine.

And what will that mean? For one thing, hundreds of billions of dollars currently invested in securities such as Treasury bills will be shifted to euro-denominated securities, according to Bergsten, who believes that as a result, the value of the dollar will fall sharply soon after the euro comes formally into existence. That could cause inflation fears to rekindle as imports get more expensive, and drive up U.S. interest rates, he warned in an interview.

Some experts take an even more dire view of the long-term consequences for a United States that continues to live beyond its means by importing $200 billion a year more than it exports.

Up to now, the United States has encountered virtually no trouble getting the money from abroad that it needs to pay its import bill, partly because of the dollar's dominant status. Foreigners selling to us, say, Sony televisions or Mercedes-Benz cars are content to take their payment in dollars and invest the proceeds in dollar-denominated securities such as Treasury bills. That's a dramatic contrast with, say, Russia or Thailand or Indonesia, which have been forced to borrow from the International Monetary Fund – and submit to its dictates – when people lost faith in their currencies.

"What America is about to lose – or, more exactly, to begin to lose – few Americans ever realized they had," wrote James Grant, the editor of Grant's Interest Rate Observer, last month. "This unique national blessing is the privilege of borrowing in the very currency that the United States alone can lawfully print. The strategic and financial value of this franchise is inestimable."

Thanks to the euro, in other words, the dollar will be less appealing for foreigners to hold. So to induce them to take dollars, American borrowers may have to offer more attractive returns – and, according to Grant, "competition from the euro will tend to cause dollar interest rates to be higher than they would otherwise have been."

But other economists dismiss such arguments as unduly alarmist.

For starters, the euro will suffer from numerous drawbacks that will limit its appeal for use in trade and finance. A person holding a few million dollars can always park it easily in the giant market for U.S. Treasuries, where dealers compete fiercely with one another so that investors need incur only modest costs for buying, selling and hedging. By contrast, the convenience of the market for euros may be handicapped by the absence of a single, Euroland-wide bond like the U.S. Treasury bond. Each country in the bloc will issue its own securities.

Even though the euro may become widely used as a substitute for the dollar, that doesn't necessarily bode ill for the United States.

Jeffrey Shafer, vice chairman of Salomon Smith Barney International in New York, said many of his firm's clients have expressed interest in borrowing and investing in euros. But the dollar's leading-currency status "isn't what allows us to finance our deficit," said Shafer, a former Treasury undersecretary. "It's that we are the world's strongest country, with rule of law and respect for property. It also helps to have a first-class financial center – and we'll still have that."

Indeed, the United States' ability to borrow in dollars came into question when inflation ran rampant in the late 1970s, and Washington felt obliged to issue bonds denominated in West German marks. As long as U.S. inflation stays low, that sort of episode shouldn't recur, Shafer said.

"The dollar's advantages will still be there," said David Hale, global economist at Zurich Group in Chicago. "But we will be experimenting with alternatives in a way we haven't done before. All one can say is, 'Stay tuned.'"