When the euro began circulating at the start of 2002, Kenneth Rogoff figured it would take 50 years for the new 12-nation currency to rival the importance of the United States dollar in world financial markets. Today, the former chief economist of the International Monetary Fund says parity could come in five to 10 years.
For the first time in many decades, perhaps since before World War I, the dollar has a serious competitor.
"Euros are coming more to the front," says Ulrich Ramm, chief economist of Commerzbank in Frankfurt. "It's a real alternative ... to the dollar."
If Washington is intent on spreading its influence in the world, the dollar's fall makes it harder - and more expensive - to expand its military and political reach.
Of course, the dollar is far from powerless. It's the currency used in most international trade. It's how oil and important metals are priced on international markets. The market for bonds denominated in dollars is far bigger, and thus more useful for many borrowers, than that for euro bonds. Nations still hold the great bulk of their international monetary reserves in dollars.
"I don't see two heavyweights slugging it out," says Richard Reid, an economist in London with Citigroup.
Nonetheless, the dollar has suffered setbacks that make the euro look increasingly attractive. Since it peaked in value three years ago, the greenback has declined 17 percent against a basket of currencies of key nations that trade with the US. The euro has 33 percent more buying power in the US than three years ago. Canadian dollars are worth 22 percent more, British pounds 25 percent.
Such dollar declines have made central bankers edgy. To manage a potential financial crisis or to prevent their national currency from rising in value, making exports less competitive, central banks around the world have stowed away almost $4 trillion in reserves, up 65 percent in the past four years. Most of those reserves are in dollar assets.
But because all the dollars on their ledgers have been losing value, the bankers are diversifying a bit into euros. A recent survey of central bank managers in 65 nations, controlling $1.7 trillion of international monetary reserves, found that 70 percent had boosted their exposure to euros in the past two years. And a near majority expect this trend to continue in the next four years, notes Central Banking Publications in London.
It's not just governments making the switch. In informal and sometimes illegal cash markets in eastern Europe and elsewhere, euros are joining dollars as a currency of choice and making "modest inroads" on the dollar, says Mr. Rogoff, now at Harvard University.
Foreigners worry about the stability of the dollar because Americans are overspending. There's the growing budget deficit, of course. But of equal importance for currency traders is the $617.7 billion imbalance between what the US buys and what it sells abroad. Americans are spending about 5.7 percent more than the nation itself produces. At the moment, the US must borrow $55 billion a month, $1.8 billion a day, to finance its massive deficit in international payments.
Over time, the decline in the dollar should readjust that balance, since US exports will become more competitive and imports more expensive. Yet many economists suspect restoring balance in the international payments of the US could take years - and another 15 percent decline in the dollar's value, mostly against Asian currencies such as the Chinese yuan, reckons John Williamson, an economist at the Institute for International Economics.
Aside from its trade impact, the weakness of the dollar has other ramifications:
• The dollar's reduced buying power limits the ability of Washington to expand military or other activities abroad. Though a large portion of the dollars spent in Iraq, Germany, South Korea, and in other overseas operations ends up back in the US, the extra costs are not trivial.
• A weaker dollar reduces the economic influence of the US in the world. Its purchases abroad will shrink relatively. Its foreign aid will be less valuable. The sliding dollar doesn't necessarily mean a loss of prestige, says Robert Hormats, vice chairman of Goldman Sachs (International) in New York. "It's really a market phenomenon." Investors worldwide are deciding to diversify their assets, to reduce risk by not concentrating so many eggs in the dollar basket.
• A boom in foreign purchases of US firms, now seen as a bargain, may have started. Last year, 1,126 US businesses were sold to foreign buyers, up from 1,032 in 2003 and 980 in 2002, says Thomson Financial, an information firm in New York.
"Europe is very well positioned to buy up a lot," says Rogoff.
• The US could see a reduction in what amounts to a giant interest-free loan for US taxpayers. All those $20 and $100 bills abroad represent more in value than they cost to print. So the US makes a profit of roughly $15 billion to $20 billion on the huge float of greenbacks outside US borders, estimates Rogoff. If foreigners shrink those holdings, America's international subsidy will also dwindle.