Wednesday, December 29, 2004

When the drug traffickers and the black marketeers are getting out of the dollar, you know a real sea change is in the works.
People the world over�central banks, companies, and individuals�like to hold the dollar. It's stable, liquid, easily convertible, and never goes out of style. The dollar is popular in the official global economy�the money that changes hands through computer terminals, checks, and wire transfers. But it has also been extremely popular in the world's vast cash economy. For American tourists, Chinese smugglers, Ukrainian arms dealers, and African dictators, the dollar has long been the currency of choice. The fearful and shady, those who subsist on tourism, and residents of countries with unstable domestic currencies love the greenback. Citing Federal Reserve estimates, Grant writes that "between 55% and 70% of the $703 billion of U.S. currency outstanding circulates outside the 50 states."

The United States benefits greatly from the fact that the dollar is the world's reserve currency. Many of the $100 bills circulating throughout the globe are essentially loans that we never have to pay back. Americans use them to buy goods, services, or other currencies. But many of those bills never return to our shores to be redeemed for anything we make or produce. Instead, they stay under mattresses in Bogot�, circulate in Iraq, and are stashed in bank accounts around the world.

But among a subset of global cash connoisseurs, the dollar is losing ground to the euro�and it has nothing to do with concerns over U.S. multilateralism. First, the euro zone has been expanding with the addition of new countries and the continued integration between Eastern and Western Europe. So there are simply more people who accept and use euros now. Since 2002, the growth rate of euros in circulation has far outpaced that of dollars. Add in the euro's recent strength against the dollar, and the case for Eastern Europeans and euro-neighbors to use euros becomes more compelling. In the 1990s, the dollar was remarkably popular in Russia, where residents had long been deprived of coveted Western imports. But between January 2002 and August 2004, Grant notes, the percentage of private Russian currency transactions employing the dollar fell from 94.1 percent to 84 percent while the euro's share rose from nothing to about 15 percent.

Finally, in the past two years, euros have also become easier to carry, store, and hide than dollars. Generally, the largest denomination of U.S. currency readily available is the $100 bill. But in the past two years, the European Central Bank has started to print 200-euro and 500-euro bills. These larger bills thus allow for the concentration of wealth in smaller packages. At today's rates, a 500-euro note is worth $682.
While 55-70% of US currency circulates outside the US, only around 10% of all euros circulate beyond euroland. Nonetheless, an interesting leading indicator to keep one's eyes on. I wonder if there is a monthly Bloomberg consensus forecast for international drug dealers currency usage?

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