With so much still to be done to underpin the euro and the eurozone, says former Dutch finance minister Onno Ruding, boosting the single currency as a rival to the dollar cannot be a top priority. He looks here at the euro’s international ambitions and achievements
During the lengthy preparations for a European single currency – spanning the Werner report in 1970, the 1989 Delors report, the Maastricht Treaty of 1991 and the euro’s introduction in 1999 – there was intensive political debate of the crucial matter of the currency’s goals. There seemed widespread agreement on the aim of strengthening the economic integration process, with the thinking being that the euro had a key role in deepening the internal market and so contributing to higher economic growth. For many politicians and economists, myself included, this economic goal was and still is the primary objective of monetary integration: an internal European goal rather than an external one.
As well as this economic and monetary aim, two other goals of a primarily (and for some politicians, purely) political character were being promoted right from the start of the process. The first goal related to the general political motives that have always underpinned French and German support for European integration. Germany gave top priority both to political integration of divided and scarred post-war Europe and to its own reunification. France gave top priority to monetary integration as a means of obtaining more influence in Europe on monetary policy (which used to be largely determined by the German Bundesbank) and to creating an international counterweight, or rival, to the US dollar. Despite the Bundesbank’s reservations, this Franco-German axis led to a political deal in which France won support from Germany for monetary union while Germany received France’s support for its reunification.
The second goal, then, was France’s long-standing wish to end the dollar’s global dominance by launching a European challenge to its supremacy. France sees monetary and even general political advantage in this aim. Although the aim was – and still is – largely a French priority, over the years I have noticed this tendency, with an anti-anglo-saxon flavour, elsewhere in Europe; in political circles in some EU countries and among some members of various European Commissions. This is, however, not a matter of black and white. I myself belong to the many politicians and economists across the Union who are concerned about the dominant position of the dollar as by far the most important global trading and reserve currency. Such a position may lead – and in fact has led – to less desirable consequences, such as making it too cheap and easy for the US to finance its substantial balance of payment deficits. But it would be going too far to make this external political-monetary goal of a prominent global role for the euro as a trading and a reserve currency a primary aim of European policy-making.
I would prefer that we focus our political attention and action on taking the many policy measures, both at European and national level that are still needed to improve the functioning of our financial markets as well as that of the euro itself – that involves the Stability and Growth Pact, national fiscal policies and the European Central Bank.
Removing the remaining obstacles and tackling the shortcomings in Europe would in the end make the euro an even more attractive alternative to the dollar as an international trading and reserve currency. Whether the euro will or will not ultimately replace the dollar (statistically speaking) as the world’s No. 1 trading and reserve currency is, in my view, a divisive and less relevant subject and should not be made an explicit policy goal.
At the time the euro was created, there was a school of thought that the new single currency would lead to greater exchange rate stability, meaning less volatility not just inside the eurozone but also vis-à-vis other important currencies, in particular the dollar. Those who adhered to this approach promoted the idea of a global system of fixed exchange rates, or currency “target zones”, as one of the euro’s goals. I always considered this unrealistic, as the opposite development seemed more likely. The creation of the euro has made the economies of the eurozone countries much less open than before. Their foreign trade (now defined as trade with non-eurozone countries) has fallen as a share of their GDP. Changes in the external value of their currency (the euro rather than their former national currency) also have less of an impact on their domestic economies. Consequently, domestic opposition to upward or downward exchange rate fluctuations has shrunk as well.I see no evidence that either the US or Europe would be (more) willing to take measures towards global exchange rate stability. Large countries or currency areas give priority to domestic economic and political objectives when setting their policies rather than to international considerations. High volatility between the euro and the dollar is therefore likely to continue.
In today’s climate in which the euro and the way it works are frequently criticised both inside and outside the eurozone, and particularly in anglo-saxon countries, the many impressive successes achieved by the euro since 1999 need to be emphasised. This has been particularly true for financial markets. The fragmented, small and inefficient national money and capital markets that used to exist have been reformed into one large integrated market with a wider choice of financial instruments and maturities, much more depth in volume, greater absorption capacity and more liquidity than before. This offers considerable advantages to all stakeholders, be they corporations and governments looking for capital, investors who are buying bonds or shares or financial intermediaries. This applies to the markets for equities and bonds as well as bank loans and markets for top quality borrowers as well as companies with non-investment grade credit ratings.
Parties outside Europe benefit from these positive effects of the euro, too. They are making increasing use of the euro in transactions for which they once used the dollar. The market for international bond issues denominated in euros has now reached a size that is almost the same as the dollar. Although this huge success has made the European single currency one of the two globally dominant financial currencies, the euro’s progress towards achieving similar prominence as an international trading currency (in which the cross-border transactions of goods and services are denominated) has been much less marked.
The euro’s role as an international reserve currency in which non-eurozone countries’ central banks hold their monetary reserves, has also increased. This development has been welcomed by most Europeans, including myself, whereas US opinions are probably more mixed. Some in Europe are even surprised and disappointed that the euro has not yet come close to matching the dollar in this respect, although I myself am not. I am unsurprised because changes in the composition of monetary reserves are always a slow-moving process. The monetary authorities in many countries apply various criteria for their decisions on reserves, and one of them is the rate of return on their holdings. The dollar currently offers substantially higher interest rates than the euro, particularly for shorter maturities.
Another factor is the value of the currency, taking into account expected exchange rate fluctuations. The value of the euro declined considerably vis-à-vis the dollar in the first few years after 1999, a fact that has made many foreign central banks nervous. Another criterion relates to the trade patterns of the country concerned. As long as a large part of their imports and exports are denominated in US dollars, there is a tendency to keep large amounts of reserves in that currency as well. Market liquidity also plays an important role and here the euro has become more attractive than the national currencies of the countries that joined the single currency. Finally, there are purely political considerations.
Overall, I should say that I am not disappointed by developments so far because I expect that over time the euro will gain in prominence as a reserve currency, and will therefore gain ground on the dollar in this respect. I do not consider this, however, to be a top priority for the euro.
The current composition of monetary reserves held by central banks around the world is that US dollars account for about 60% of these holdings, followed by the euro, which is slightly above 25% and growing and well ahead of other relevant currencies like Britain’s pound sterling, the Japanese yen and the Swiss franc, each of which accounts for less than 5%. Rather than setting politically motivated and artificial targets to help the euro rival the dollar in terms of its global importance, I would prefer that we in the EU and the eurozone adopt economic and monetary policies that are appropriate in their own right for the EU and the eurozone respectively. They may over time indirectly create the conditions for the euro to become even more important as a global reserve currency.