Why the euro is unlikely to eclipse the dollar

Quote: Judging from commentary by international economists, one would think that the dollar was on its deathbed. America’s financial crisis and the dollar’s depreciation are bringing us to a tipping point where the greenback will lose its international currency mantle to the euro. A few more losses on dollar investments, it is said, and central banks will learn to hold their reserves in euros. Other investors will follow. America’s “exorbitant privilege” will be no more.
To paraphrase Mark Twain, these reports of the dollar’s death are greatly exaggerated. They are based on a model of the demand for international reserves that does not apply to our 21st-century world.
The chief idea of this model is that international currency status is a source of network effects. Just as it pays to use the same computer software as other people in your network, it pays to use the same international currency as other official and private market participants.
Central banks thus find it attractive to hold dollars because other central banks hold dollars. With everyone doing likewise, the market in dollars is deep and liquid. Because trade is denominated in dollars, central banks find them convenient to smooth the balance of payments. This network externality is the source of the exorbitant privilege that the dollar has enjoyed for half a century.

Full article: http://www.ft.com/cms/s/0/14049bf2-00b1-11dd-a0c5-000077b07658.html

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