Dollar Vs. Euro

1. Introduction

Since the appearance of the EURO (Ђ) in the international trading system, the American dollar ($) has lost its domination and role in the financial world. Consequently, there is not only a great disparity in the exchange rate between the two currencies in favor of the EURO, but a growing problem in the US economy as well. Table 1, which can be found in Appendix B, shows the course and relationship of the exchange rates of the two currencies from 1999 until now.

The scope of this paper is to approach as best as possible the various reasons for this disparity and try to predict the future of the two currencies based on accurate and up-to-date information. At this point, the authors would like to make clear that they do not intend to criticize or praise any political or financial behaviors, but to present the facts objectively.

1.1. Short History of $

The appearance of the first American dollar goes back to August of 1786 when the Congress approved it as the official American unit of account for the United States. Until 1874 the value of the United States dollar was tied to and backed up by silver, gold, or both. In Table 2, which can be found in Appendix B, we can see the relation of the gold and dollar from 1954 up to 2003.

Another term closely associated with the dollar is the so called petrodollar. This is a term that was given by Ibrahim Oweiss, a professor of economics at Georgetown University, in 1973 to describe the dominance of the American currency over the international oil market. The same conclusion is coming out from Chart 1, where we can see that in 1973 the gold value of the American dollar fell almost nine times, because it was no more connected with the gold standards.

1.2. Short History of Ђ

As of January 1st 1999, banks, foreign exchange dealers, big firms and stock markets, celebrated the first appearance and circulation of a new electronic currency called EURO. This was the outcome of the agreement between Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain. Two years passed until the EURO became a legal tender. From this point onwards, the EURO secured the preference of many investors, who previously supported the American dollar.

Until now, Eurozone, counts 13 members including Greece and Slovenia, apart from the 11 previous countries, and in the next months will add two new members in its family. This shows that more and more countries believe in a united monetary system, which will provide security and stability in their economies, through its steadiness.

An example of the rapid growth and usage of the EURO is that, as of December 2006, more than Ђ610 billion euros are in circulation. This is equivalent to US $802 billion at the exchange rates at the time. In other words, the euro surpasses the US dollar in terms of combined value of cash in circulation.

This issue has led to a shadow war between the EURO and the American dollar for the world's financial dominance.

1.3. The Shadow War

The undeclared war between the two currencies started almost immediately after the launching of the new electronic monetary system. Although, at the beginning, the EURO was very weak and it did not pose a threat for the dominance of the American dollar, analysts had expressed their agony and thoughts about the future of the American currency. Their instinct was not wrong, since year by year the EURO was strengthening against all currencies and nowadays has the highest exchange rate of all years against the dollar.

On the other hand, most probably, the FED and the US governments underestimated the bold movement of some European countries, and taking into consideration that for the first three years the Euro was loosing ground, they did not create safeguards for the case of the Euros future recover. As a result, we are facing the current issue of the great disparity between the two currencies.

There are several reasons that have led to today's situation, which will be analyzed later on, but namely the most important ones are the interest rates, the imports and exports, the circulation of euros against dollars, the ability of European Union to expand in contrast to the US's land lock, and last but not least the war for the oil or in other words, the petrodollar against the petroeuro.

At this point we should clarify that the exchange rates are influenced by the combination of the reasons mentioned above. Nevertheless, we will try to break them down and examine them individually.

2. Interest Rates

One of the most important factors that affect and change the exchange rates is the interest rates, which are announced by the FED and the ECB.

With the terms FED and ECB, we refer to the Federal Reserve System and to the European Central Bank. The former is the central banking system of the United States, whereas the latter is one of the world's most important central banks. However, both of them are responsible for the monetary policies in the countries or states that they are consisted of, by setting a wide variety of rates, in order to stabilize their economies.

The two main and general rates which affect the exchange rates are the borrowing rate and the deposit rate. Currently, the rates for the United States are 5.25% and 5.25% respectively, whereas for the Eurozone the rates are 5% and 4% respectively. This means in simple and broad words that it might be more profitable for someone to borrow money from the Eurozone, since he will have a gain of 0.25%, but it will be more profitable if someone deposits money in the US. Nevertheless, interest rates on their own cannot help us to reach secure conclusions on why there is such disparity between the two currencies. Thus, we have to take into consideration all of the following reasons as well.

3. Inflation

Nonetheless, interest rates are closely related with the concept of inflation. By the term "inflation" we mean the overall general upward price movement of goods and services in an economy.

Both FED and ECB are trying to maintain the levels of inflation in such rates that will allow further growth without the consumers loosing their purchasing power. Thus the FED has succeeded into stabilizing the inflation at 2.69% for the US, whereas ECB has a rate of 1.9% for the Eurozone.

The calculation of the inflation is based on two indices. The first is the Consumer Price Index, or the CPI, and is a measure of the price of a set group of