When the euro first came into being, it was worth about $1.17, and for some time, it traded at a value less than a dollar. By 2009, the euro reached record highs against the U.S. currency, hovering near $1.50. The drastic actions taken by the Federal Reserve and other central banks in 2008 postponed serious economic calamity resulting from the credit crisis. But they also had serious currency implications that has left the U.S. dollar weak against the euro.
Supply and Demand
Like anything else, the value of a currency is dictated by the forces of supply and demand. Demand for a currency is created by economic growth and investor interest, while supply is regulated by the monetary policy of central banks. In response to a deflationary crisis, the Federal Reserve vastly increased the potential supply of dollars, lowering the value of the dollar.
One reason why the dollar is weak against the euro is relative interest rates. The U.S. reacted more quickly to the economic contraction resulting from the credit crisis by slashing interest rates. The European Central Bank (ECB) waited several months longer to begin easing rates, and never took rates as low as did the Federal Reserve. In the U.S., the Fed’s benchmark rate was lowered to essentially zero, while the ECB paused with rates at a record low of 1 percent.
Another major reason the dollar slipped against the euro was quantitative easing. This refers to a monetary policy strategy in which the central bank lowers its quality standards on collateral it accepts for loans to increase the overall volume of lending it can perform. While the Federal Reserve has participated in quantitative easing to stimulate the domestic economy, the ECB has resisted such measures as of 2009.
Independent of the credit crisis and the monetary policy of central banks, the first decade of the 21st century saw a major global trend toward diversification of currency reserves that had the inevitable effect of weakening the dollar. Large holders of foreign currency reserves, especially China, said it was in their best interest to diversify their holdings into euros and other currencies rather than primarily dollars. Several major oil-supplying countries have also expressed a desire to price oil in euros and local currencies rather than dollars, questioning the dollar’s status as the world’s lone reserve currency. These major shifts in demand for dollars are longer-term forces favoring the euro over the dollar.
Despite the constant mantra from Washington that a strong dollar is in the best interests of the United States, there are several interests for whom a weak dollar is actually a boon. Primarily, these are domestic companies with strong foreign presences who realize windfall profits as they repatriate money earned overseas. But even with the forces aligned against the dollar, there is considerable opposition around the world to letting the dollar fall too low because of the implications for international trade. Plus, with sluggish growth likely in Eastern Europe, there are probably limits to how low the dollar can slide against the euro.