It does not seem so very long ago that foreign currency traders nicknamed the euro "the toilet currency", because it was going down the pan. That is true no longer. The euro is soaring high, while the dollar is flushed away.
So is this the end of the dollar's reign as the world's dominant currency? The answer is almost certainly "no". But the dollar has a true competitor for the first time in nearly 90 years. This could have important, though largely beneficial, effects on the world economy.
The US dollar has been the king of currencies since the first world war, when it began to dethrone the pound sterling. Its primacy survived the great inflation of the 1970s and the vast swings in its external value during the 1980s and 1990s. But now, for the first time, it is weak when a plausible rival is strong.
The shift in the dollar's role is, none the less, slow. By the end of the second quarter of 2007, for example, only a quarter of the foreign currency reserves whose denomination could be identified by the International Monetary Fund were held in euros, up from 18 per cent when the euro was launched. Meanwhile, the dollar's share had fallen to 65 per cent, from 70 per cent in the beginning of 1999.
Euro-denominated notes and coins in circulation exceed those denominated in dollars. The €500 note must surely be the gangster's (and tax evader's) cash of choice. The value of bonds issued in euros since the beginning of 2006 exceeds that of bonds denominated in dollars. Long-term interest rates are also lower in euros than in dollars. The euro then is a credible currency, used in an ever more integrated monetary area second only to the US in size.
Moreover, the decline in the dollar's external value has been precipitous. Against the euro, the dollar has fallen by 40 per cent since its peak at the end of January 2002. On JPMorgan's broad trade-weighted index, the real value of the currency has fallen by 28 per cent since February 2002. It is now lower than at any point since 1980. This fall has happened even though the total value of foreign currency reserves rose by just under $4,000bn between February 2002 and September 2007. Since the US currency has been the principal beneficiary of these enormous support operations, its value would surely be far lower today in their absence. This is a measure of the vulnerability created, above all, by the enormous US current account deficits of the 2000s.
None of this means the dollar is yet on its death bed. The decline in its external value is, instead, a necessary part of the adjustment of the trade imbalances of recent years. US capital markets remain large and liquid, even if the reputation of Wall Street has been damaged by the credit squeeze.
Yet the primacy of the dollar is no longer to be taken for granted. Should wealth-holders (both foreign and domestic) come to doubt the determination of the Federal Reserve to preserve the dollar's domestic purchasing power, they might dump it, with devastating effects on its external value, long-term US interest rates and the US economy. When wealth-holders look at the scale of indebtedness in the US, they might conclude that the Fed is indeed going to be under vast pressure to choose inflation.
One big fact is that foreign governments can now credibly peg their currencies against a basket of currencies or even just the euro alone. Another one is that both they and others with liquid wealth now have a choice of two currencies. When the renminbi is at last made convertible, they will have another one. Competition among currencies is good for actual and potential holders, but painful for those used to their currency monopoly.
What Charles de Gaulle called the dollar's "exorbitant privilege" can no longer be taken for granted. The US will have to earn it on a daily basis, instead. That may be unwelcome for the US. But it will be good for nearly everybody else.
Copyright The Financial Times Limited 2007