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Euro as de facto Global Currency?

Kick the can down the road

The cur­rent global fin­an­cial crisis has iron­ic­ally pro­duced a rather sur­pris­ing and benign unin­ten­ded con­sequence. Since fin­an­cial glob­al­iz­a­tion has shaped the world’s mac­roe­co­nomic paradigm after the Bretton Woods sys­tem, the cur­rent status quo has come under fierce cri­ti­cism. More spe­cific­ally, the dollar’s “exorbitant privilege” is no longer con­sidered to be a gran­ted right, in par­tic­u­lar after the reck­less­ness of U.S eco­nomic activ­it­ies prior to the fin­an­cial melt­down has become evid­ent. Fur­ther­more, the evol­u­tion of the inter­na­tional mon­et­ary sys­tem has pro­duced a mul­ti­-c­ur­rency sys­tem, in which  emer­ging and exist­ing strong eco­nom­ies are armed and ready to chal­lenge the dol­lar as the de facto global currency.

Euro Rises Up

How about the Euro? Euro-zone exports, mostly gen­er­ated by the Ger­man eco­nomy, are twice as large as the U.S exports. Fur­ther­more, due to the com­mon mar­ket where the trans­ac­tion and con­ver­sion expenses are in the past, coun­tries and com­pan­ies may settle trade pay­ments using the very same cur­rency and elim­in­ate the risks of exchange rate fluc­tu­ations. Dur­ing the recent global fin­an­cial crisis when the emer­ging eco­nom­ies have accu­mu­lated vast amounts of reserves to arti­fi­cially set the value of their cur­rency, the Euro-zone coun­tries have the priv­ilege to avoid such fluc­tu­ations and volat­il­it­ies. There­fore, the net-work value of the Euro has become com­par­able to the dol­lar, given that the external demand for Euro increases due to its poten­tial strength.

ECB=FED

A com­pet­it­ive and cred­ible reserve cur­rency needs to have a solid cent­ral bank behind it. The Fed­eral Reserve is the bas­tion for the dol­lar, where infla­tion and interest rates are rel­at­ively well con­trolled to sup­port the inter­na­tional mon­et­ary sys­tem. Con­sequently, dur­ing the fin­an­cial crisis, investors rushed to U.S T-bills to pro­tect their money from the fin­an­cial con­ta­gion. At the same time, the ECB’s per­haps polit­ic­ally unpop­u­lar decision to pur­chase gov­ern­ment bonds from the “junk­yards” exhib­ited sim­ilar firm determ­in­a­tion of the Euro-zone’s abil­ity to adjust their unbal­anced fiscal order. Cer­tainly if the mar­kets had lost faith in the Euro as a strong and safe inter­na­tional reserve cur­rency, the Euro would not rep­res­ent 28 % of the world’s total accu­mu­lated reserve cur­ren­cies or 31 % of all inter­na­tional bond issues.

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Still so Far Behind

At first quick glance at the Euro, one might won­der why it is not per­form­ing to its poten­tial. There are vari­ous reas­ons for such a puzz­ling situ­ation, but cer­tainly the first and fore­most is the fact that the Euro is a cur­rency without a state. Not backed by a single gov­ern­ment and rejec­ted by cer­tain mem­bers of the European Union, the dream of the Euro being the “chosen” dom­in­at­ing cur­rency is quite frankly unfore­see­able. The inab­il­ity to dis­card the myopic polit­ical dif­fer­ences and the col­lect­ive reluct­ance to share the bur­den of the bail-out pack­ages have pre­ven­ted the Euro to rival the dol­lar as a ser­i­ous altern­at­ive for a new global reserve cur­rency within the frame­work of the new world order. Secondly, in order to become the “banker of the world” a coun­try has to have eco­nomic growth. Unfor­tu­nately, the European Union will not enjoy growth in the near future after fall­ing back to a reces­sion at the end of the last year. Although the GDP growth of the United States is sim­il­arly minus­cule, the cur­rent IMS struc­ture allows the U.S to run cur­rent account defi­cits because the U.S must provide stable liquid­ity to the world mar­kets. Such para­dox is bet­ter known as the Triffin Dilemma.

What Can Be Done?

The Euro may in the future rise above its con­tenders. Given the geo­graph­ical expan­sion of the EU, the the­ory of optimal currency area applies more to the Euro than to any other cur­rency bloc. As the num­ber of coun­tries increases in a given area, the volume of trade sub­sequently increases as well. There­fore, if the num­ber of cur­ren­cies decreases due to integ­ra­tion, the eco­nom­ies of scale deriv­ing from one cur­rency would gen­er­ate suf­fi­cient bene­fits, which encour­age other coun­tries to accu­mu­late the very same cur­rency to make neces­sary adjust­ments in their bal­ance of pay­ments. Secondly, if the Euro-zone suc­ceeded in gen­er­at­ing adequate insti­tu­tional reforms, such as provid­ing the ECB more power in over­see­ing the fiscal prudence of its mem­bers and enhan­cing the com­pet­it­ive­ness of the com­mon mar­ket, the cred­ib­il­ity and prob­ab­il­ity of the Euro becom­ing an influ­en­tial cur­rency in the new inter­na­tional mon­et­ary sys­tem will be higher. But for now, the “exorbitant privilege” of the dol­lar prevails.

– Henry Erti

Dis­claimer: This art­icle was ori­gin­ally pub­lished as ”  Euro as de facto Global Currency? ” on February 3, 2013 in The European Student Think Tank, a PB cooper­a­tion partner

 

(Photos: AttributionShare Alike  Images_of_Money, Creative Commons, Flickr)

 

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