Why the euro cannot realistically rival the dollarby Paul Wallace / January 5, 2019 / Leave a comment
The Brussels eurocrats should know better. Ahead of the tenth anniversary of the euro, born at the start of 1999, the European Commission celebrated the single currency’s “resounding success.” The monetary union was “an achievement of strategic importance” for the world at large by making Europe “a pole of macroeconomic stability.” The ensuing euro crisis brutally exposed the hollowness of these claims as the currency bloc nearly fell apart as well as weakening the global economy.
Undaunted, a decade later as the 20th anniversary approached, Jean-Claude Juncker set out the goal of strengthening the international role of the euro, as part of a broader mission to increase the European Union’s heft in the world. In his final “state of the union” speech last autumn the Commission’s president declared that “the euro must become the face and the instrument of a new, more sovereign Europe.”
Whether this vaulting ambition for the euro is that desirable is open to question. As long ago as the 1960s France took issue with the “exorbitant privilege” of the United States, owing to the dollar’s role in underpinning the international monetary system. In the era of floating exchange rates since the early 1970s, the main benefit for the US is lower borrowing costs thanks to foreign purchases of American safe assets. Yet that tends to keep the dollar stronger than would otherwise be the case. If the euro were genuinely to rival the dollar, eurozone businesses would have to cope with a stronger currency—rather than the weak one that has propped them up over the past few years thanks to the European Central Bank’s ultra-loose policies.
Whatever its pros and cons, Juncker’s exalted vision won’t happen. At first sight, the euro might appear to merit a more influential role. Europe’s monetary union has after all stuck together, expanding from an initial membership of 11 countries in January 1999 to the current rollcall of 19. The euro area has managed a continuing if uneven recovery since the double-dip recession between mid-2011 and early 2013, growing particularly fast in 2017. At market exchange rates, it is second only to the US in the size of its economy (though China will soon push it into third place). The euro is widely used beyond the confines of the currency club (such as in Montenegro) while countries like Denmark peg their currencies to it.
The euro is undoubtedly the world’s second most important currency, but it is a distant second to the dollar. The status of a currency shows up above all in its portion of foreign-exchange reserves held by central banks. The euro’s share over the past 20 years reveals a dismal story of dashed hopes. According to the most recent figures from the IMF, which are for the end of the third quarter of 2018, the single currency makes up 20 per cent of global reserves. That’s little higher than its 18 per cent share in early 1999, after reserves held predominantly in the form of Deutsche Marks had been converted into euros.
“The inadequacy of a currency that lacks a state was laid bare in the turmoil of the euro crisis”
Furthermore, the euro’s current share marks a step backward since a high almost a decade ago, when it had risen to 28 per cent (at the end of the third quarter of 2009). That contrasts with the dollar’s current share of 62 per cent, the same as when the euro reached its peak, and only a little lower than its 65 per cent share at the end of 1997, a year before the launch of the euro.
Other indicators paint a similar picture. A new composite index published last June by the European Central Bank, which covers the euro’s share not just in global foreign-exchange reserves but in international bonds, cross-border loans and deposits, and foreign-exchange settlements, showed that the euro has gone back to square one in its international standing.
The dollar’s continuing preeminence is unsurprising from a historical perspective. Once established, a dominant international currency is hard to dislodge. Sterling clung on into the 20th century even though Britain’s economic power had long dwindled. Similarly, the dollar has remained on top since the second world war even though the American economy no longer stands head and shoulders above others as it did in the late 1940s.
There are compelling economic reasons why an incumbent international currency is hard to challenge. In his speech last year Juncker lamented the fact that the bulk of European energy imports were paid in dollars. But for a single commodity such as oil that is traded round the world it makes sense to price it in the world’s existing main currency. For the oil producers who receive the revenues there is far more scope to invest in dollar-based assets than in euro-based ones.
More important, the dollar is backed by a state whose debt is backed by national taxpayers. By contrast the euro is a currency that lacks a corresponding state. The members of the monetary union remain far from creating the complementary fiscal and political union that would permit the creation of a common public debt market supported by eurozone taxpayers.
The inadequacy of a currency that lacks a state was laid bare in the turmoil of the euro crisis. The euro managed to pick itself up from its hospital bed after more than two years of acute crisis, when Mario Draghi made his famous vow in July 2012 to do “whatever it takes” to save the single currency. But even a commitment from the ECB’s president could not protect the euro from the near-exit of Greece in 2015. Such a departure would have put a permanent question mark over the supposed irrevocability of the monetary union, stoking doubts about other struggling countries following suit.
It is easy to proclaim an ambition for the euro as a global rather than a regional currency. But if Europe really wants to achieve that goal then it must do the difficult things, starting with further substantive steps to strengthen the institutions underpinning the still fragile monetary union. Beyond that lies the far trickier agenda of much deeper fiscal and political integration. This currently appears unfeasible as the pull of the nation state reasserts itself and populist leaders such as Italy’s Matteo Salvini make the running. Yet unless it can be achieved, the ambition to enhance the clout of the euro will be empty rhetoric.