The history has seen changes, rises and falls of an international reserve currency, emerging with an increased role of sterling in the 19th century and replaced by U.S. dollar in the 20th century (Eichengreen, 2006; Flandreau and Jobst, 2006). The emergence of euro has influenced a lot the whole world in many aspects and it is not a doubt that its introduction improved the functioning of euro financial markets, especially if we look from the perspective of transaction costs and country specific economic risks (Freix, 2004). It is the fact that euro is rapidly approaching U.S. dollar in terms of liquidity and breadth of euro financial markets. But at this level U.S. dollar is still maintaining its leading role on the international financial markets, maybe because of its greater financial market size or the inertia in the use of financial resources.
The objective of this paper is to analyze different aspects of challenges U.S. dollar faces today. What are the chances for euro to surpass U.S. dollar and to become the leading currency.
The first section of the paper gives a brief history about an international currency development, the second and the basic part gives some theoretical aspects and reviews the ideas of different economists about the challenges dollar face. All these discussion leads to the final part - conclusion.
Before the few decades of World War I, international gold standard emerged. It was gold bullion and not a gold coin standard, which was the 19th century innovation. It meant coin and paper money convertible into gold bullions. Britain was the world's preeminent trade nation making up 30% of the world's export in 1860; 20% in 1890 and the 60% of the world's trade invoiced and settled in sterling between the years 1860 and 1914, as it was appropriate for a lot of foreign suppliers for entering the British market. The preeminence of sterling until 1914 can be considered as the evidence of existing only one international currency at any point in time. It was sterling, replaced by dollar and we should guess what will be the next.
In 1914, the Federal Reserve System was established, which increased the attractiveness of the New York market as a financial center. During the post-World War II period, while Europe suffered with the consequences of the war and the countries with potential alternative currencies to the dollars, maintained a great capital controls. This explains the dominance of dollar in reserves during a long period after World War II and in addition, the rapid growth of US economy played a significant role in establishing dollar as an international currency (Eichengreen, 2005).
In 1944 major market economists gathered in Bretton Woods to discuss the post-war monetary system. Keynes developed the idea about advantages of creating an international currency-Bancor, but there was no political will from countries to give up their national currencies. At the period, U.S. was the strongest economy and the Breton Woods meeting agreed on creating International Monetary Fund that would be anchored to the dollar - the only international currency convertible into gold by central banks (Swaminathan S. Anklesaria Aiyar, 2009).
The balance of payment surplus with U.S. was the only way for other countries to earn dollars. In 1958, United States started to face large balance of payment deficits that was a result of Europeans trade surpluses. As an overall result, in 1971 U.S. closed the official gold window thus finishing the Bretton Woods regime. (Menzie Chinn, Jeffrey Frankel, 2005) All these facts had an influence on the development of U.S. dollar as an international currency.
Nowadays Euro, the currency which physically occurred in 2002 and is used by 12