Euro Heading to Replace Dollar as World’s Most Liquid Currency

Kristian Rouz – As tensions rise in international politics, propelling FX markets’ demand for the US dollar to fresh highs, the US Fed seems utterly unable to fend off the greenback’s harmful strength. On the other hand, the Euro finds itself on track to become the new dominant currency in global finance.

The dollar’s availability for most emerging markets has severely diminished during the past 18 months as the Fed has been approaching its historical decision on raising borrowing costs. Meanwhile, the improving health of the Eurozone economy coupled with near zero inflation are pushing European Central Bank (ECB) head Mario Draghi to expand the current stimulus program by several hundred billion euros, effectively flooding the global FX markets with cheap hard-currency liquidity.

During the past three decades, international investors had been little bothered by political violence and international tensions across the globe, as an abundance of the inexpensive dollar provided enough financial resources to hedge against political risk. Now, as the US dollar is on the rise there is less wiggle room for market participants, resulting in rife financial volatility here and there caused by political concerns.

According to a recent report by Bank of America, 18 percent of surveyed fund managers cited international politics to be the biggest risk during the past month, compared to 38 percent fearing a recession in mainland China and 23 percent concerned with debt meltdown in emerging markets. While a significant share of fund managers’ concern is attributed to local factors, such as Islamic terrorism and mainland China’s structural problems, the destabilizing impact of the dollar’s strength is a major challenge to sustainability to the most fragile parts of the global economy.

Meanwhile, the recent terrorist attacks in Paris, France, failed to affect the nation’s finance. France’s main stock index, the CAC 40, fluctuated within its normal trading gauge following the outbreak of violence. More recently, the spark of political tensions between Russia and Turkey provided only a minor shock to international financial markets, while the domestic political instability in Germany resulting from a speculation that the Merkel cabinet might resign over the immigration crisis did not affect the nation’s bourse at all – the DAX Index actually rose amidst the media controversy.

The reason is that European investors are increasingly reliant on the ECB providing an abundance of euro liquidity, slowly pushing the US dollar off the trading floors. The US Fed might be consciously retreating into economic isolationism as the United States is relying more on their domestic market in terms of growth and output. Besides, Germany has emerged in the recent years as a major industrial exporter and Europe is challenging the US’s technological dominance in emerging markets as well.

US Fed-controlled assets are now worth some 25 percent of US GDP, while the ECB’s balance sheet is roughly 20 percent, and as Draghi considers adding to bond-buying beyond the current $1.2 trln program, the ECB’s prominence in global finance is bound to rise.

The tightening by the US Fed would diminish the dollar’s fluidity in global markets, and even more so as global devaluation trends are still intact. Meanwhile, as the ECB is pumping even more euros into the world economy, Frankfurt’s cut in global finance is poised to exceed that of Washington. As political tensions rise across the world, investors will use more affordable financial tools, and in this regard, a cheaper euro looks more promising than an expensive dollar.