Euro Bust

The below picture is from yesterday’s front page of the Wall Street Journal. The €500 euro note is a lot of money, equivalent to $625 in U.S. currency at today’s exchange rate. The pictured woman in Spain is protesting against the bank bailout. Visibly showing such a large denominated note in a crowded place carries risk. Good thing that the note is a fake.

Picture via The Wall Street Journal

It is unheard of in America for someone to display anything larger than a $100 bill. But the $625 equivalent amount inherent in the €500 has been actively promoted since its creation and it is not uncommon to see such a large note getting passed around in Europe, even among American tourists.

One of the goals of the euro was to dethrone the U.S. dollar as the world’s reserve currency and achieve the status of a global currency. There are probably more U.S. dollars floating around outside the U.S. than here in the U.S. Think of Russians saving their money not in rubles but in U.S. dollars, carrying the recent memory of when the old ruble totally collapsed and wiped away years of savings just a few years ago. People in Argentina also have a good memory of a lifetime of peso savings turning into dust overnight. In U.S. history, those in the antebellum South would also have experienced the sudden worthlessness of the “greyback” after the Civil War. The fear of currency collapse is why people in Iran today smuggle and save their money in U.S. dollars as they do not trust their government. The same thing is likely occurring in Venezuela.

The mere idea that the printing of paper (the U.S. dollar) has value gives America an extraordinary privilege over other countries. Imagine how you would feel if you had the printer could just spit out few hundred dollar bills every now and then that carry real purchasing power. That is just the feeling and the privilege that the U.S. government with the Federal Reserve holds. America can print and print, and use the money to buy things without worrying too much about inflation and the loss of value.

From the launch of the euro, it looked as if the euro could indeed push aside the dollar. The euro greatly strengthened against the dollar from 2001 to 2008. By circulating the €500 note as a common occurrence, it was hoped that Russians would rather have fewer euro note than a large number of dollars, particularly as the euro was appreciating in value. Criminals could also perhaps switch over to the big euro note, necessitating a thinner and lighter suitcase full of money. Interestingly though the drug dealers, illegal arms traders, and Somali pirates have consistently demanded only dollars as payment and not euros. Perhaps they understood the difficulty and the suspicions that would be raised in exchanging such a huge euro note for everyday use in countries outside of Euro Zone.

Irrespective of initial goals, the euro simply cannot be sustained if there are countries like Greece unwilling to live within their financial resources. The current euro problem has therefore by default resulted in the U.S. dollar getting stronger. That is why the U.S. government can borrow at exceptionally cheap interest rates and why U.S. mortgage rates are at unbelievably low levels (for those who qualify).

The only challenge to the dollar, though not anytime soon or even within a decade, is the Chinese Yuan. All metrics suggests the yuan will strengthen against the dollar on a sustained basis because it does not carry a large budget deficit and has a sizable trade surplus. If Iranians, Russians, and the outlaws truly begin to believe that this will be the case in future than the dollar could be dethroned. U.S. interest rates and mortgage rates will then be much higher.