Abstract
This paper will
examine whether the euro could surpass the American’s greenback or it is likely
to continue to exist as a subordinate currency. In order to do that we need to
focus both on economics and politics as they directly or indirectly affect the
role of the euro. In this article we will argue that even though the
introduction of the euro in 1999 had considerable implications for the global
financial, monetary, and economic system, the euro as a medium of exchange, as
a store of value, and as a unit of account remains and it will continue to
remain the second global reserve currency in the world. Moreover, it could be
argued that not only the Eurozone the last ten years suffers from serious
deficiencies that negatively affect the euro’s leading role as a global reserve
currency but also the political and institutional conditions do not favor such
evolution. Under these conditions it could be said that it is unlikely for the
euro to overcome the pre-eminence of the US dollar as a global reserve
currency.
1. INTRODUCTION
In 1999, the single
European currency (euro) was adopted by eleven founder members of the European
Union (EU). It was the last step for the creation of the Economic and Monetary
Union (EMU) whose idea was negotiated on the Treaty of Rome, was reinforced by
the Delors Report, and was consolidated by the Treaty of the EU in 1991.
Despite the remarkable success, some aspects of the project remained
unsuccessful (Bladen, 2007). The last European crisis is a clear result of this
failure in which many important issues remain questionable. One of them is
whether the Euro can ever be a global reserve currency. The answer for this
question is not so obvious because each currency’s global role has to be earned
(Baldwin and Wyplosz, 2004). The birth of the Euro triggered a new area of
theoretical discussion and a new rival among the most prominent scholars was started.
The global financial and economic crisis that began in 2007 has been a good
opportunity for the euro to overcome the US dollar and as Cohen (2009, p. 742)
states ‘the joint currency of the EU could legitimately aspire to join
America’s greenback at the peak of global finance’. However, it could be said
that this aspiration does not seem to be feasible. Not only because of the
current European systemic crisis but clearly because of the systemic flaws and
disadvantages that exist within the whole structures of European economic
governance and their relation with the American counterpart. Thus, even though the euro has become a
strong regional currency both in Europe and the Mediterranean, it has not
challenged the dollar as the world’s leading reserve currency and the European
economic governance during the crisis has not strengthen the euro’s
international role (Pisani-Ferry and Sapir, 2009). In this context, as
Callinicos (2009) believes the global economy may confront a new period of
currency uncertainty.
Under
these circumstances this essay will examine whether the euro could surpass the
American’s greenback or it is likely to continue to exist as a subordinate
currency. In order to do that we need to focus both on economics and politics
as they directly or indirectly affect the role of the euro. In this respect,
this paper will begin by noting some theoretical explanations for what a global
reserve currency is, and it will then go on to explain under which conditions a
currency can ever be a global reserve currency. The second section of this
paper will evaluate the current relationship between the US dollar and the euro
in order to answer the question whether the euro can ever be a global reserve
currency from economic perspective. In the third section we will focus on the
role of politics and how the system of the European economic governance affects
the euro’s primacy. In this regard, it is important to say that the current
European crisis does not affect the outcome of this paper because the crisis is
just the result of euro’s long term inconsistency. In this article we will argue that even
though the introduction of the euro in 1999 had considerable implications for
the global financial, monetary, and economic system, the euro as a medium of
exchange, as a store of value, and as a unit of account remains and it will
continue to remain the second global reserve currency in the world. Moreover,
it could be argued that not only the Eurozone the last ten years suffers from
serious deficiencies that negatively affect the euro’s leading role as a global
reserve currency but also the political and institutional conditions do not
favor such evolution. Under these conditions it could be said that it is
unlikely for the euro to overcome the pre-eminence of the US dollar as a global
reserve currency.
2. THE DEBATE
From the
early beginning many scholars agreed that the euro will challenge dollar’s
global dominance. However, these early predictions had one main difference, the
time period that this could happen. Alogoskoufis and Portes (1997) believed
that the full parity could be happened shortly after the introduction of the
euro. In this case, the macroeconomic fundamentals could play a significant
role. Other believed that the euro could surpass the dollar as a global reserve
currency after a long period (Eichengreen, 1998). For Fred Bergsten (1997,
p.91) ‘the euro’s rise may have to await a serious policy lapse by the United
States’. Furthermore, Chinn and Frankel (2005) predicted that if the thirteen
candidates and potential candidate countries join the EMU by 2020, the euro
will be able to surpass the US dollar as a global reserve currency. In
contrast, other studies argued that this is not likely to happen (Feldstein,
1997; Cohen, 2003). As it is said three years after the global financial and
economic crisis the dollar’s role as an international currency not only
retained but also was reinforced (Cohen, 2009). After nearly thirteen years it
can be said that none of the positive expectations was affirmed.
Before we
proceed to the evaluation of whether the euro can be a global reserve currency,
a closer explanation of theoretical issues is needed. In general, each currency
has three functions; it can be used either as medium of exchange, or as a unit
of account, or as a store of value. In addition, the most prominent scholars
acknowledge three main dimensions for the assessment and evaluation whether the
euro will ever be a global reserve currency. These are the trajectory, the
scope, and the domain. According to Cohen (2009) there are two levels of
analysis: the private market and the public policy (official sector) in which
role of the euro can be analyzed. The analysis of the euro as a reserve
currency mainly belongs at the level of public policy under which the euro has
two functions as a medium of exchange and as a store of value. However, the
euro as a unit of account in its public policy sector is related with exchange
rate decisions as an anchor currency. The table 1 below shows the roles of an
international currency.
Table 1. Roles of an international currency
Source: Galati and Wooldridge (2009).
A global
reserve currency is the currency that it controlled by the monetary public
authorities (official sector) for the implementation of three main targets. It
can be used to maintain either the exchange rate capabilities, or to mediate in
foreign exchange markets, and/or to guarantee wealth (Galati and Wooldridge,
2009). Moreover, there are four main elements that affect the formation of a
global reserve currency. Namely, these are the size of the economy and the
global share in output and trade (Eichengreen, 1998; Bergsten, 1997), the
macroeconomic stability (Hartmann and Issing, 2002) and macroeconomic
fundamentals (Alogoskoufis and Portes, 1997), the creation, size and liquidity
of foreign exchange financial markets (Eichengreen, 1998; Cooper, 2000) and the
network externalities (Rey, 2001). In addition it can be said that the
institutional structure is a key factor that influence the creation of a global
reserve currency (Eichengreen, 1998). In this sense, not only the rejection of
the UK to be a member of the Eurozone reduced euro’s ability as a global
reserve currency but also its impediments in the euro bond markets (Portes and
Rey, 1998).
Under the
aforementioned conditions it could be said that there exist many factors that
could undermine the US dollar’s role as a leading global reserve currency.
Among of these are the macroeconomic fundamentals, like the net external debt
of the US or the EMU’s function (Eichengreen, 2005; Flandreau and Jobst, 2006).
As Portes and Rey (1998b, p. 308) state ‘Given the euro’s fundamentals-the EU’s
economic size, the liberalization and integration of its financial markets, and
confidence in its international creditor status and stability oriented monetary
policy- we find that the most likely outcome is that the dollar will have to
share the number one position’. However,
as Cohen (2009, p.742) believes ‘the real issue is not price but use: the
extent to which the euro is being adopted by actors outside EMU for the standard
functions of a medium of exchange, unit of account or store of value’. Under
these conditions the US dollar has sustained not only its international role
but also its role as a global reserve currency.
It seems that the greater size of dollar financial markets and the
inertia in the use of international currencies have helped to this respect[1].
3. The Role of Economics
3.1. Composition of official reserves
As Galati
and Wooldridge (2009, p.4) state ‘the euro’s share of reserves is higher today
than it was immediately prior to monetary union, but it is still well below the
US dollar’s share and below even the share of euro legacy currencies in the
1980s and early 1990s’. This is clear in Figure 1 that shows the currency
composition of reserves as a percentage of total allocated foreign currency
holdings for the US dollar, the euro legacy currencies until 1999 and the euro
until 2006 respectively.
Figure 1. Currency Composition of Reserves.
US Dollar Euro-1999
Euro-2006
Source: Galati and Wooldridge (2009).
As it can
be observed from the figure above the minimum point for the US reserves and
deposits was in 1990 with 45% and the maximum point was in 2001 with a share of
70% in global reserves and deposits. It could be said that this supports
Cohen’s (2009) argument that during crises the dollar’s role as an
international currency is reinforced. Furthermore, it is clear that in 2004,
five years after the creation of EMU, there was a significant difference
between the euro and the dollar in reserves and deposits, although the dollar
has decreased to 66% and 59% of reserves and deposits respectively.
Figure 2. Emerging Markets Official Reserves
Source: Alexandraki 2009.
Moreover,
as it can be observed from the figure 2 the vast majority of official reserves
in emerging markets are still concentrated in the US dollar (Alexandraki,
2009). In addition, it can also be said that after 1999 the euro’s total share
in industrial and developing countries increased but this improvement was
geographically limited (Lim, 2006). The aforementioned arguments shows that
indeed, the euro not only is by far the second currency in official reserves in
developed and in developing world but also that it seems to be only a regional
currency.
3.2 Medium of Exchange
In order
to analyze whether the euro can ever be a global reserve currency, when it is
used as a medium of exchange, one should focus on liquidity conditions in
foreign exchange markets and in money and government securities markets. First,
it is ambiguous if the liquidity of the euro challenges the dollar’s liquidity
in foreign exchange markets. It is clear in Figure 2 that the dollar’s
percentage in foreign exchange markets changed only slightly from 1992 to 2007
(Galati and Wooldridge 2009).
Figure 2. Foreign Exchange Markets Turnover.
Source: Galati and Wooldridge (2009)
Moreover,
as it can be observed from the Table 2 which shows the currency distribution of
foreign exchange market turnover from 1989 to 2007, the dollar is the sovereign
currency, and no other currency can overcome its dominance. In this sense, as
Cohen (2009) believes not only the euro in contrast with the dollar is not
equally distributed across the regions but also the euro is not functions as a
vehicle currency globally. Consequently, as he states ‘outside the European
region, the use of the currency for trade with EMU economies remains limited;
in transactions between third countries, where neither counterparty is an EMU
member, it is practically non-existent’ (2009, p.751). It is clear that as one
can observe from table 3 which shows the currency shares on foreign exchange
market transactions in Asia, the leading dollar’s role is unambiguous as a
vehicle currency. As a result, it can be argued that the dominant role of the
dollar in world trade cannot be challenged by the euro (Kamps, 2006; Henning,
2009).
Table 2. Currency Distribution of Foreign –Exchange Market Turnover
Source: Bank of International Settlements (2008).
Table 3. Currency
Shares on Foreign Exchange Market Transactions
Source: Henning (2009).
Second,
as Cohen (2009, p.752) states ‘the securities markets have proved to be, by
far, the area of greatest success in the internationalization of the euro’.
However, even though the EMU has developed the most significant alternative in
government securities market at the end of 2005, as it can be noticed from
Table 4, in
2005 the total outstanding stock of securities was 6,4 trillion for the yen,
4,7 trillion for the euro, and 4,2 trillion for the dollar, the magnitude is an
inadequate standard for a judgment against the dollar (Galati and Wooldridge,
2009). In addition, ECB’s (2008) annual review of the international role of the
euro points out that the euro’s share of international bank loans remains at
the same level since 1999 and in the case of international deposits stands
lower. The primacy of the dollar in both cases is incomparable. As a result, it
can be said that the dollar seems to posses important benefits against the euro
like the wider bill market, the greater homogeneity and the higher credit
quality of the treasury market, and the huge liquidity in US Treasury market.
Table 4. Government Securities Markets
Source: Galati and Wooldridge (2009)
Third, it
can be observed from the table 5 that between 2001 and 2005 the outstanding
value of repos increased from 3 to 4,7 trillion and from 3,4 to 6,1 trillion in
the euro and dollar market respectively (Galati and Wooldridge, 2009). It is
clear that from 2001 to 2005 the dollar’s repos market has dominated the euro’s
repos market. The aforementioned denomination against the euro is also
observable in the cases of overnight maturity, of tri-party agreements and in
collateral transactions.
Table 5. Repos Market
Source: Galati and Wooldridge (2009)
As a
result, it can be argued that although the euro has, as a medium of exchange,
increased its global role not only in foreign exchange markets but also in
government securities and repo markets, it is not clear whether it could
challenge the more widespread traded and more liquid US dollar.
3.3 Unit of account
As a unit
of account the euro in public sector is used as a monetary anchor. In this
context, it is important whether the euro has developed a significant gravitational
role. According to the figure 3 it can be noticed that the euro the last decade
has increased its global role but it is not again clear if this change could
create a new global dominator in reserves. As Galati and Wooldridge (2009, p.
16) state ‘Since 2002, the US dollar has depreciated against many currencies,
and so the higher co-movement of currencies with the euro may reflect temporary
dollar weakness rather than a long-term increase in the euro’s influence’.
Furthermore, from the introduction of the euro it can be counted that nearly
forty countries pegged their exchange rates with the euro but it is ambiguous
whether this development represent a demonstration of the euro’s greater
international role or its regional character (Cohen, 2009). Moreover, it can
also be said that the majority of the countries that have aligned their
currencies with the euro are smaller as compared with the larger financial
economies that have pegged their currencies with the dollar. As a result, as
Cohen (2009, p.755) states ‘If any currency is exerting increasing
gravitational force, it would appears to be the greenback, not the euro’.
Figure 3. Exchange rate sensitivities with respect to dollar/euro rate
changes
Source: Galati and Wooldridge (2009)
3.4 Store of value
As a
store of value each currency can be used as a reserve of accumulation because
every currency is related to purchasing power and macroeconomic stability.
Moreover, Galati and Wooldridge (2009, p.16) state that ‘the store of value
function of an international currency is linked to the breadth and depth of
financial markets’.
Figure 4. Total Reserves
Source: Galati and Wooldridge (2009)
In this
case, as it can be observed from the figure 4 above the magnitude of total
reserves increased from 1978 to 2005 more than 7%. In this respect, the
monetary authorities like the central banks not only use the total reserves for
monetary targets more but also they have increased their importance as a
monetary and intervention tool. It is clear that from the table 6 that from
1999 to 2008 the euro share of official foreign exchange reserves increased
from 17,9% to 25,5%. The same evolution can be observed also from the figure 5
which shows from 1995-2008 the development of the dollar and the euro as official
reserve currency. However, according to the ECB the euro’s share of global
reserves is quite misleading because in constant exchange rates its share
decreased (ECB, 2008). Indeed, it can be argued that the euro’s trajectory
after its fast start has remained stable (Cohen, 2009).
Furthermore,
it can be argued that the introduction of the euro in 1999 created the second
largest market after the US market in the world in terms of the euro securities
markets and in credit quality and it has been noticed that in liquidity terms
the pre-eminence of the US dollar is now declining (Galati and Wooldridge,
2009). Moreover, in terms of international bonds and notes it can be observed a
substantial rise in the use of the euro (Cohen, 2009). However, as Cooper (2000)
states the attractiveness of the US dollar as a reserve currency derived from
the existence of a deeper and more liquid market in US treasury securities and
in particular in treasury bills compared with euro markets. In this sense, this
seems to become the core problem not only for the euro but also for the Eurozone.
As Cohen (2008, p.44) argues ‘the euro is condemned to remain at a disadvantage
vis-à-vis the dollar as long as EMU is unable to offer a universal financial
instrument that can match the US treasury bill for international investor
liquidity and convenience’.
Table 6. Dollar and Euro Shares of Official Foreign Exchange Reserves
Source: Cohen (2009)
Figure 5. The Dollar and the Euro as Official Reserve Currency
Source: Mayer (2009).
4. THE ROLE OF POLITICS
In the case of political considerations one could say
that there are many structural limitations and deficiencies that negatively
influence the euro’s role as a global reserve currency. Even though it can be
argued that in economic output and trade the EU is in many cases in a better
position than the US[2], the EU today faces three
main substantial imbalances on trade, on productivity and on budget deficit
that affect its sustainability. Moreover, in the institutional domain, as Eichengreen
(1998) argued, the institutional structure and the lack of supervisory and
regulatory authority of the ECB are likely to have a negative impact on the
euro’s prospects as a global reserve currency.
According to him, even the US dollar, during the conflict period among
the sterling and the dollar, was not able to capture the primacy from the
sterling because of the initial absent of the Federal Reserve.
As Benjamin Cohen (2003) has clearly observed from the
early beginning, the EMU’s ambiguous governance structure reveals uncertainties
and confusion for its prospect primacy. It could be said that the
aforementioned deficit is the most prominent of all. According to him the EU
needs to solve three main issues on the governance of the ECB, the problem of
the exchange rate policy, and the uncertainty about the political authority
responsible for macroeconomic issues in the Eurozone. Under these conditions
the Eurozone seems to be an artificial creation. In this sense, Cohen (2008,
p.38) states that ‘the euro is a currency without a country-the product of an
interstate agreement, not the expression of a single sovereign power’. In
addition, McNamara and Meunier (2002, p. 850) believe that ‘as long as no
single voice has the political authority to speak on behalf of the euro area,
as the U.S. Secretary of the Treasury does for the American currency, the
pre-eminence of the US in the international monetary matters, as in other
realms, is likely to remain unchallenged’. For Cohen (2009, p.744) ‘the euro’s
handicaps includes troubling ambiguities in EMU’s governance
structure-difficult to avoid when a single currency is jointly managed by more
than one sovereign state-as well as a strong anti-bias built into the bloc’s
provisions for monetary and fiscal policy’. In this case, it can be said that
the permanent limitations of the euro appear to have weighted on EMU’s
legitimacy and there is a need for other significant mechanisms of
legitimization different than that of economic fundamentals[3] (Deroose, Hodson and
Kuhlmann, 2007). For Hodson (2009) the EU has failed to produce a European
vanguard because the decision-making lies on the national level.
It is also
clear that even today two years after the Greek financial crisis the European
Union’s political leaders seem unable to solve the crisis because of the weak foundations
and architecture of the Economic and Monetary Union. The EMU is a unique
example of transnational economic and political cooperation, but it is full of
flaws and problems. From its early beginnings the political leaders accepted in
many countries that in fact couldn’t be competitive within the Eurozone. There
are two important economic laws that affect their sustainability negatively.
The first law is the transformation of comparative advantage to absolute
advantage within the Eurozone. This means that within the Euroland only the
most competitive enterprises can survive. Thus, the states stand unable to help
the industries and the entrepreneurs. The second law argues that it is impossible
to have a symmetric and balanced economic growth within the whole area of the
Eurozone. In this way, we can explain the occurrence of two major different
areas of economic growth within the EU, namely the core countries and the
peripheral countries. Under these conditions, many countries of the European
periphery that have been unable to remain competitive in the Eurozone joined
the EU only because of political priorities and decisions. These actions are also
highly responsible for the euro’s inability to surpass the US dollar.
Moreover,
the system of European economic governance is not a well-rounded system that
can help all its diverse countries in remaining competitive. The European
Central Bank (ECB), although it is a highly credible institution, does not
function as the American Federal Reserve. Thus, because the European economic
integration is uneven, when the ECB takes a monetary decision, e.g. changing
the interest rates or the money supply, the outcome of this decision does not
have the same effect on all European countries. In this regard, the ECB cannot
help Greece or countries similar to Greece. Furthermore, the Stability and
Growth Pact (SGP) has also many omissions and we can’t forget that France and
Germany were the first two countries that failed to comply with its targets.
Furthermore, the EMU suffers from asymmetric and adverse economic shocks,
inflexible labour markets, rigid wages, centralization of economic activity to
specific areas, incomplete trade integration, and uncoordinated monetary and
fiscal policies. Together with its major institutional weaknesses and the fact
that a European political union is not regarded as feasible and the European
sense of solidarity is inexistent, the result is ruinous both for the European
project and for its member states. In fact, Greece and many other largely
peripheral countries remain trapped within the Eurozone. They cannot use either
their monetary or fiscal policies to regain their competitive advantage. This
is also an important lesson that the New Member States (NMS) must learn. Living
within the Eurozone is not as simple as it looks. Accordingly, the European
Economic Governance is not only responsible for the Greek crisis but also for
the euro’s inability to suppress the US dollar as the global reserve currency.
Furthermore, it can be said that the EU’s political
influence is considerably decreased beyond its neighborhood (Posen, 2008). As
Posen (2006, p. 11) argues ‘recent
developments obscure the reality that the euro is at a temporary peak of
influence, and the dollar will continue to benefit from the geopolitical
sources of its global role which the euro cannot yet or soon, if ever, match’.
In this context, Momani (2008) believes that even though it can be found a
global currency as an alternative to dollar, no state can be found to replace
the US security umbrella. Adam Posen (2009, p.99) clearly points out that ‘because
the euro area is not offering to the states behind potentially associated
currencies a broader range of security relationships in general, it will not
attract as many adherents as the economic factors would seem to suggest would
come’.
As a
result, it can be said that not only the euro has significant institutional and
political obstacles to overcome but also it is almost unlikely for the EU to
defeat the preeminence of the US in political affairs. It seems that it is
unlikely for the euro to overcome the dollar’s primacy. As Mundell (1993, p.10) states ‘Great powers
have great currencies’ and in this case in contrast to the US neither the EU’s
currency nor its global political influence is significant. In this context,
Frieden (1998, p.38) was right for his argument that ‘political realities of
today’s EU will define the future of the euro’.
5. CONCLUSION
In
conclusion, it is clear from the aforementioned analysis that the euro’s global
leading role is vague. The euro not only as medium of exchange, as a store of
value, and as a unit of account has an unambiguous international position, but
also it suffers from important institutional and political deficiencies and
limitations that influence its role negatively. In this sense, it could be said
that it is very difficult for the euro to overcome the dollar’s dominance as a
global reserve currency. The euro could be the second global reserve currency
but not the leading currency. Even though Eichengreen (2009) believes that the
euro is the only reasonably major opponent, it could be said that the decision
for a currency to become a global reserve currency is not influenced only from
economic but also from political and institutional factors. However, it can
also be said that as Eichengreen (2009, p.67) argues the dollar ‘it will not be as dominant as in
the past, for the same reasons that the United states will not be as dominant
economically as it once was’. In this case, the euro will be able to earn only
a small part of the dollar’s dominance but not the primacy. It could be said,
that many other political and economic factors could affect the future not only
for the euro but also for the dollar. In this context, one could focus on the
role of the China as the main catalytic factor for the road ahead (Bowles and
Wang, 2008).
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