CIAO DATE: 08/05

The Euro and the World Economy

Abstract

The dollar has been the dominant currency of the world economy for almost a century for a single overwhelming reason: It had no competition. No other economy came close to the size of the United States. Hence no currency could acquire the network externalities, economies of scale and scope, and public goods benefits necessary to rival the dollar at the global level.1 A similar situation for the United Kingdom explains sterling's dominance in the 19th century.

The clearest historical evidence for this conclusion is the fact that the dollar continued to reign supreme during prolonged periods of very poor economic performance by the United States:

• Its economy grew very slowly for two full decades, from the early 1970s through the early 1990s, with productivity growth that was especially mediocre (at 1.5 percent or less per year).

• It experienced high inflation for almost a decade, from 1973 through 1981, including three years of double-digit price increases.

• It has run large external deficits for most of the past 30 years, including two periods when those deficits were rising at clearly unsustainable rates (1982-87 and 1998 to the present), and had become a debtor country by the late 1980s.

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