The Coming Battle of the Atlantic: Euro vs. the Dollar

Kenichi Ohmae is author of The Borderless World and a co-founder of the strategic management practice at McKinsey & Co.

Tokyo — Because Americans are more proactive than the Japanese, they are likely to avoid the same kind of deep slump as we had for almost a decade. Nonetheless, with the value of their key assets—their homes—diminished, they will become a land of cautious consumers. This, in turn, will cause China's export growth to slow down, which will then affect Japan and the other East Asian economies that have been driven over the past several years by China's appetite for everything from tech components, machinery and scrap steel from Japan to minerals from Australia. Already worried about inflation, China's leaders are for the moment wary of over-stimulating domestic consumer demand to take up the slack of the new American caution.

So, a slowdown in the United States economy to 1 percent or less will affect us all in the short term.

Several years down the road, however, this will change as the US becomes increasingly less important to Chinese and world growth, in part because of its slowdown. After the Cold War, the US was the locomotive of the world economy. Today, there are dozens of engines, from Peru to Turkey to Nigeria to Brazil, all going full blast. Europe is already fairly well decoupled from the US economically, with 85 percent of all trade among states in the European Union, Russia and the former Soviet states. And this will be the case with Asia one day as well.

The current weakness of the American economy that has resulted from borrowing abroad to sustain high growth, and of which the subprime crisis is a symptom, is also driving the dollar to historical lows. This is causing China, Japan, the Gulf states and Russia, among others, discreetly, but inexorably, to begin fleeing the declining dollar in favor of the sounder currency of the euro. When all is said and done, the European Union will have the world's largest consumer base and integrated infrastructure. If Russia were to one day join even in some loosely related way, the EU will also have its own energy supply.

One so-far-unacknowledged consequence of this shift is that America will be increasingly forced to engage in "international trade" like the rest of us for the first time since it became a hegemonic power. When the dollar loses its lead role as the world's reserve currency because its trading partners are shunning the greenback, Americans will have to pay for Toyotas in yen, Chinese toys in renmimbi and Louis Vuitton in euros just like everyone else.

This trajectory sets the stage for "the battle of the Atlantic" between the euro and the dollar as America heads for relative decline. It will be very hard for America to control this flight from the dollar as it accelerates. When this happens, all those dollars out there in the world—the US has minted double what it needs for its domestic economy—will head home and stimulate the kind of hyperinflation we once associated with Brazil. This in turn will drive many Americans themselves to seek euros and other currencies beside the dollar that will hold their value.

The only way to restore stability in the wake of this upheaval is for the Americans and the Europeans to sit down and come to an agreement about the value of their currencies in this period of transition from one reserve currency to another, or others. Ultimately, it may make sense for the US and the European Union to combine their currencies to create a new reserve unit.

What we are seeing in this tale of financial crisis and reserve-currency flight is a power shift that replaces the US as the core of the world economy. A decade from now, the European Union will emerge, along with Turkey and linked to Russia, as the largest economy. The US will remain impressive, but in second place. China will be third. India will be fourth. Japan will be fifth. That is the world into which America's current financial crisis affords us a window.