Jan. 5 (Bloomberg) -- What a difference a couple of years make in the currency markets. The once mighty dollar is now sliding; the once feeble euro is surging.

Question is, when will the euro supplant the dollar as the No. 1 global currency? Answer: When Asia says so. Central banks in this region hold vast amounts of dollar assets, meaning they'll decide the dollar's fate. And monetary authorities here are still overwhelmingly invested in dollars.

There are two reasons. One is lingering skepticism about the stability of the euro in the age of global terrorism and the economic outlook. The euro's two pillar economies, Germany and France, recently set a terrible precedent for smaller members by tossing aside budget deficit limits. Imagine what lesser economies may try to get away with.

Two, holding dollar assets allows Asian central banks to avoid the thing that scares governments: a falling dollar. Asia worries a continued drop in the currency of the world's biggest economy will choke off its post-1997-crisis recovery. So, for better or worse, the dollar remains king and will remain as such until Asians turn to the euro.

It's a good news, bad news scenario for Europe. Good news because its single currency is finally winning the trust of investors; bad because the euro's 20 percent rise versus the dollar last year is making economies less competitive and crimping growth.

Currency Flows

European economies and companies have been bearing the brunt of Japan's huge yen sales. By devaluing the yen, Tokyo indirectly boosts the euro, too.

That the fate of euro bulls and dollar bears largely rests with folks in Asia means investors are paying closer attention to currency flows. Analysts who once spent Thursdays poring over the Federal Reserve's money supply figures now dissect the Fed's ``custody holdings'' data with similar enthusiasm.

The data shows which currencies monetary authorities are buying and selling. In mid-November, foreign central bank holdings of U.S. Treasuries exceeded $1 trillion for the first time and are still rising, largely because of Asian purchases. Between January and August alone, Asian holdings of U.S. debt jumped more than $100 billion.

Export Dependence

Yet even continued dollar-asset purchases by Asians can't save the U.S. currency if investors turn against it. The dollar's decline last year reflected investor concern about U.S. imbalances, namely record current account and budget deficits.

For Asia, a full-blown dollar crisis would be disastrous. It would send shockwaves around the globe and prompt investors to move into less risky assets. It's not clear Asia offers the kinds of ``safe-haven'' investments to which capital would flock. Also, it would slam the purchasing power of U.S. consumers, whose buying patterns are now the source of Asian optimism.

An orderly drop in the dollar also could have big implications for Asia. In the short-run, it could hurt the region's export- dependent economies. In the long run, though, the trend could reap huge benefits in Asia, which remains overly fixated on exchange rates.

Asia has been pumping up economies for years by holding down currencies. The export-your-way to prosperity strategy has worked marvelously. Now that Asia is growing and stock markets are rising, it's time to try another approach and get out of the trap of export dependence.

Confidence

Rising currencies are a sign of confidence in an economy, not a problem. Capital they bring in can be more important than the increased trade afforded by softer ones. Holding down currencies to boost growth distracts economies from fixing their real problems.

It also delays the correction of one of the world's most dangerous bubbles -- the U.S. current account deficit, which is about 5 percent of the economy. Many analysts think a weaker dollar is necessary to narrow the gap.

Finally, countries require healthy currencies to support stock markets that are playing unprecedented roles in economies. They are needed to hold down interest rates, too. That boosts growth and helps companies raise money in the bond market instead of borrowing from banks. Asia is trying to broaden bond markets; here is a way to accelerate the process.

Currency Pegs

What signs should investors who are wondering when Asia will buy fewer dollars be looking for? For one, the end of currency pegs in the region, which would give central banks less reason to horde dollars. Currencies officially pegged to the dollar include China's, Hong Kong's and Malaysia's; de facto ones include Japan's.

Tokyo has a certain dollar/yen level in mind and spent a record 17.8 trillion yen ($165 billion) from January through Nov. 26 to hold the currency there. Its unprecedented yen sales are raising eyebrows in Frankfurt and elsewhere in Europe. It wouldn't be surprising to see Japanese officials come under more pressure in 2004 to stop manipulating their currency at the expense of European growth.

While the dollar remains the reserve currency, the euro's success is gaining attention here in Asia, where economists talk more and more about adopting a common currency. Yet that hasn't translated into the kind of euro buying that might end the dollar's reign.

The dollar, for better or worse, remains the currency of choice in Asia. The euro may indeed be No. 1 someday soon, but not until this region gives the okay.

Last Updated: January 4, 2004 10:01 EST