Consolidating the euro’s position on the world stage
|© Emrah Turudu|
Prior to the launch of the third stage of Economic and Monetary Union (EMU) in 1999, speculation abounded about how much of an international role the single currency would play. The general consensus was that the euro would be welcomed internationally but opinion was divided between those who argued that the euro would be unable to challenge the mighty dollar and, at best, would become a strong regional currency, and those who maintained that it would eventually evolve into a major global currency.
So the rapid rise of the euro as an international currency surpassed the expectations of even the optimists. “The international role of the euro is one of the single currency’s successes,” emphasises Antonio de Lecea, Director of the International Affairs Directorate at DG ECFIN, responsible for the external aspects of EMU. “In some international currency functions, the euro has made substantial gains since its introduction. In particular, the euro has become a leading financial currency where, on some measures, it has even surpassed the dollar.”
For instance, the euro’s share of international debt securities, such as government and corporate bonds, is greater than that of the US dollar, with the single currency accounting for nearly half of the world’s stock (see chart).
In addition, the euro has become the second most used reserve currency, accounting for about
26% of world official reserves, and the second most actively traded currency in foreign exchange markets worldwide, accounting for 37% of all transactions in recent years.
It has also become a major medium of international trade, particularly for euro-area and other European countries. The single currency is also used as a parallel currency in neighbouring regions, such as the Western Balkans, as well as several other transition and developing countries.
“The size of the euro area and its financial system, which is comparable to the US economy, as well as its stability-oriented macroeconomic framework, support the international role of the euro,” explains de Lecea. “The recent volatility of the dollar may have also contributed.”
EMU as a source of inspiration
Other regional groupings around the world, from Asia to Latin America, Africa and the Middle East, are watching the EMU project with interest, hoping to draw lessons and inspiration for their own efforts to forge closer economic and financial integration and, possibly, monetary union.
“There is no EU policy aimed at ‘exporting’ the euro model to other regional blocs. Each region has its own unique conditions and the EU’s experience is not necessarily applicable elsewhere,” notes de Lecea. “But other regions can draw lessons from our experience and we are co-operating on financial and monetary integration issues with our ASEM partners in Asia, the MERCOSUR countries in Latin America and the Gulf Co-operation Council (GCC) in the Middle East.”
Stock of international debt securities: broad definition (1)
(1) Including home currency issuance if targeted to the international market.
As a reflection of this, at this year’s Brussels Economic Forum, Haruhiko Kuroda, head of the Asian Development Bank, spoke of how “Asia has been particularly interested to see how the euro has helped promote prosperity and financial security in Europe.
“The euro has played an essential role in fostering harmony among diverse economies which had conflicting monetary and fiscal policies, tariffs and other restrictions on trade and investment,” he added. “This experience is extremely useful for Asia… In its move towards greater co-operation and integration, Asia is looking to Europe for practical experience.”
Partly inspired by the success of the euro, the six-member GCC launched its own common market in 2008 and plans to launch its own single currency, provisionally called the Khaleeji.
The fruits of leadership
The international status of the single currency has conferred certain benefits on euro-area members. Perhaps the most important advantage is that, by attracting more investors, both within the EU and globally, it contributes to the deepening and development of the euro area’s financial markets and of its financial system more generally. The single currency also reduces the costs of doing trade internationally by making trading partners more willing to pay and accept payments in euro.
Another relatively modest advantage is that of international seigniorage. In simple terms, seigniorage refers to the fact that non-residents and other countries strive to hold reserves denominated in that currency, enabling the issuing country to print a certain amount of extra money at little real cost. A related benefit is that euro-denominated government bonds become more liquid which helps euro-area governments to borrow at somewhat lower interest rates.
Then, there is the so-called ‘exorbitant privilege‘, which enables the issuer of an international currency to cash in on the fact that its foreign assets are denominated in other currencies while its foreign liabilities are denominated in its own currency, thereby transferring the exchange rate risk to its trading partners. This, as well as the liquidity premium on its government bonds just mentioned, contributes to producing an excess return on its foreign assets over its foreign liabilities, which makes it easier for the issuer of an international currency to finance large current account deficits, while limiting the deterioration in its net foreign debt position. There is evidence that the US has benefited from this. However, the flip side of this benefit is that, as the US has learnt, it can fuel runaway deficits and potentially weaken the currency.
The euro has also benefited the wider world. Available evidence suggests that, at a time of dollar volatility, the euro has provided a much needed anchor for the global economy. “The euro has fostered stability in the euro area. This has had global spillovers and the single currency has become a pole of stability in the world economy. The diversification advantage of the euro has brought with it a large measure of global stability,” explains de Lecea.
The global status of the euro also carries with it some risks and responsibilities. Left unmanaged, it could make the euro area vulnerable to economic shocks in other parts of the world, reducing the euro’s global stabilising influence. The major challenge here is the fractured nature of the fiscal and financial policies of euro-area countries, and the fact that they act nationally in international fora.
“The euro has an important international role but our presence in international fora is still very fragmented,” observes de Lecea. “We have responsibilities towards ourselves and the rest of the world, so we need to rise to the challenge.”
Antonio de Lecea suggests that the euro-area countries should become more actively involved in global economic and financial governance. Ideally, this would involve consolidating the euro area’s representations in international fora, such as the IMF and G7. This would not only give the euro area more international clout, but would also free up seats for emerging economic powers.
Naturally, this is an ambitious goal and will have to be approached gradually, but the foundations for this unified approach, including a stronger coordination of European positions within such fora as the Eurogroup and ECOFIN councils and their committees, are already in place and the EU has already achieved such a common position on external trade issues.
The euro’s international role is likely to continue to grow gradually, but how far it will challenge the pre-eminence of the dollar depends on numerous factors, including progress in creating more integrated and liquid financial markets in the euro area, the capacity of the euro area to speak in a cohesive manner on global economic matters, and the US’s own policies. While incumbency advantages and inertial forces will continue to favour the dollar for some time, the international monetary system is likely to evolve over time towards a more symmetric system, with both the euro and the dollar acting as the main international currencies.