Almost everyone who ever visited Europe has probably come back with the odd pound, franc, lira or mark that they never got around to exchanging for dollars. They should hold on to them, because they are going to become collector's items.
In a few months, they will cease to exist. All members of the European Union are withdrawing their individual currencies and coins from circulation, and replacing them with something called the "euro." If the United States wishes to keep the dollar dominant in international commerce and finance, it needs to respond to this challenge.
The euro has actually been around for a couple of years. It was formally introduced on January 1, 1999, but since has been available only for bank transactions. People can hold euros in bank accounts but still must use national currencies for cash transactions. However, national currencies are now linked to the euro, so that exchange rates are largely fixed. This has led to a convergence of inflation and interest rates throughout the EU, exactly as economic theory predicted.
To the dismay of Europeans, however, the euro has not become as popular outside Europe as expected. They thought the euro would quickly challenge the supremacy of the dollar as the currency of choice in international commerce and finance. But although the euro was initially valued at $1.19, it has fallen fairly steadily to a current value of just 86 cents.
Europeans hope that withdrawal of national currencies and replacement with euro notes and coins will revive interest in the euro. They have even taken steps to give euros an advantage over dollars, by printing large quantities of 1,000 and 500 euro notes -- much bigger than the largest U.S. currency in circulation. The largest dollar note available is the $100 bill. Although $500, $1,000 and larger bills exist, none have been printed since 1946, and since 1969 the Treasury Department has withdrawn them from circulation.
The problem is that there has been a lot of price inflation since 1946. A $100 bill today will only buy what $11 bought then. That is a key reason why U.S. currency per capita has risen from $179 in 1950 to $2,146 today. But because the Treasury adamantly refuses to supply the demand for larger bills, people have little choice but to hold more and more of their cash in the form of $100's. Such bills now account for 67 percent of all U.S. currency outstanding, twice the percentage as recently as 1979.
Another reason for the growing use of $100 bills, of course, is the underground economy, both here and abroad. This includes not only criminal activity, such as drug dealing, but much ordinary commerce that people simply wish to avoid reporting to tax collectors. Because taxes are so much higher in Europe, the underground economy there is about 50 percent larger than here. Estimates by economist Friedrich Schneider of Linz University in Austria put the underground economy at about 16 percent of the gross domestic product in Europe in 1994. It ranged from a low of 13.1 percent in Germany to a high of 25.8 percent in Italy. His U.S. estimate is 9.4 percent -- in line with previous calculations.
Kenneth Rogoff, recently named chief economist at the International Monetary Fund, believes that the EU's decision to issue notes larger than $100 is a de facto effort to gain "market share" in the underground economy. Historically, dollars have been the preferred medium of exchange in this area, which explains why the U.S. "exported" more than $22 billion of currency in 1999. This helped finance much of the U.S. current account deficit.
Of course, much underground economic activity in Europe takes place in local currencies. But with their elimination, those with large stashes of cash have to do something with it before the end of the year. It would appear too suspicious to law enforcement officials if they tried to exchange large quantities of unexplained cash for euros next year. The result has been a spending boom throughout Europe, as people rush to buy tangible assets with their underground cash.
In Spain, this has led to a real-estate boom that has driven housing prices up by 27 percent in the last 2 years. In The Netherlands, the unexpected repatriation of underground cash from abroad has caused the guilder to fall by 7.9 percent.
Economists generally applaud introduction of the euro, believing it will facilitate commerce and growth throughout Europe. It would help the dollar compete if the Treasury once again issued $500 bills. After all, they will only buy $56 worth of goods compared to when they were last printed. It would also help continue to make the dollar the world's most desired medium of exchange, from which all Americans benefit.