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Dumping the dollar may be a fine idea, but we nevertheless need an international currency-like instrument for settling international payments. Governor Zhou is well aware of that, and quickly followed up on his outburst with a more sedate statement that the People’s Bank of China was definitely not about to sell its dollar mountain, but from now on would be acquiring other reserve assets than U.S. dollars, euros for instance. That of course raises the question of whether the euro could displace the dollar in the vaults of central banks around the world? Unlikely though it is, let’s assume that it could happen and ask ourselves what would change?
The first thing to change would be the seigniorage business. World international reserves amount to some €4,000bn and are likely to keep on rising fast if China and other emerging-market countries insist on accumulating ever greater foreign currency holdings. Would that mean the instant enrichment of the European Central Bank (ECB)? Hardly, as reserves are mostly held in the form of government bonds which pay interest. Governor Zhou and his colleagues would have to fish for bonds from governments they perceive to be as safe as that of the U.S., and which are also able to issue enough bonds to meet the needs of central banks. The total debt of the eurozone governments currently amounts to about €9,000bn, but not all of that is considered to be top quality. The supply of euro-denominated instruments that are adequate to be held elsewhere as reserves is not that large. The German government, which issues the Bund futures contracts, could of course oblige by running large budget deficits for as long as the euro were to remain the world’s reserve currency, but it is far from sure that this would be a very welcome development.
Still, some seigniorage would be earned as people around the world store banknotes, whether for good reasons as a safe-haven for cash, or for bad (illegal trade) reasons. The euro has in fact already won a significant share of this market, with some €100bn worth of banknotes shipped abroad by the ECB, which compares to about $400bn in U.S. banknotes circulating outside the United States. Some additional benefit would accrue to eurozone governments because their borrowing costs in what would have become the leading world currency would decline, but the overall effect is unlikely to be massive. Over the last decade, European interest rates have not been systematically higher than American ones. Where the U.S. really made a profit was by borrowing from the likes of Governor Zhou at short maturities and low interest, and then lending elsewhere at long maturities and higher rates. Lending is the business – and profit – of banks, and that’s a reflection of the towering role of Wall Street. If the euro were to gain a truly international status that could help challenge Wall Street, but that would also require serious changes in the way European governments deal with their financial markets and financiers. My own bet would be on London, already the leading market for euro assets, to reap the profits rather than Frankfurt or Paris.
Why, then, do so many people in the world want to see the end of the dollar’s supremacy, and why do some in Europe get excited at the prospect of seeing the euro become currency supremo? If the economic advantages are limited and financial domination unlikely, what’s left is political power. The dollar is often seen as America’s wonder weapon and the source of its dominance in international economic and financial negotiations, so the question is would Europe capture that role if the euro were to become the main reserve currency?
A first answer concerns the IMF. Power within the Fund is formally determined by quotas and, for the time being at least, the quotas do not directly acknowledge a currency’s reserve role. Indirectly, however, if countries wanting to borrow from the IMF were to insist on borrowing in euros, that could have some effect, albeit a tiny one, on the complicated formula. The only way the euro area could wield more power has nothing to do with the role of the euro itself but relates to the “balkanisation” of Executive Directors in the IMF’s Board. Eight of the 24 board members are European, each with a smallish voting power. The case has long been made for all eurozone countries to merge into a single constituency with a single Executive Director, who would then have more voting power than his U.S. counterpart. It has yet to happen, though, because no EU country is willing to give up its own seat for the common good.
It is also far from clear what the dollar’s role as the world’s reserve currency confers in practical term on the U.S. in international economic and financial terms. America’s GDP is in any case by far the highest in the world, and will be for many years to come. The euro area’s overall GDP is close to that of the U.S., but there is nothing like a single eurozone voice, no more than there is a single eurozone Executive Director at the IMF. And Wall Street is by far the single largest financial centre in the world, with the City of London only a distant second. And if U.S. banks do not necessarily top the world league in terms of size (it used to be Japanese banks, then Swiss and British banks), the truth is that nowadays big banks may be more a curse than a blessing. In financial as in economic matters, therefore, America’s domination is towering and this may much more explain U.S. influence in world affairs than does the special status of the dollar.
As noted earlier, the euro’s accession to international currency status could open a window of opportunity for European financial markets. To reap this advantage, however, continental Europeans would need to start developing a love affair with their financiers, even though this is certainly not the direction in which they have been moving of late. Germany’s Chancellor Angela Merkel has even expressed the opinion that the U.S. model has been shown to be deeply flawed. It is of course, and although the solution she proposes might perhaps make it safer, it would certainly not make it better-performing. Nor does French President Nicolas Sarkozy’s berating of “financial capitalism” suggest that Paris is about to mount a convincing challenge to New York, not least because the Paris Bourse now belongs to the New York Stock Exchange, just as do those of Amsterdam and Brussels. For the foreseeable future, continental Europe is unlikely to provide fertile ground in which finance can flourish.
Finally, could the ECB one day challenge the U.S. Federal Reserve? In a way it already does. Financial markets around the world pay nearly as much attention to ECB president Jean-Claude Trichet’s utterances as to those of Fed chairman Ben Bernanke. The reason is that ECB policies determine developments in an economic area about as big as the U.S. economy. And it is less and less the case that the dollar’s depreciation is seen as an appreciation of all the other currencies. Nowadays, public comments and perceptions recognise that for one currency to go up another must go down and the euro is often the other one. Nor is it that commodity prices blindly follow the fate of the dollar. Sure, oil prices are still formally set in dollars but that does not mean that they are fixed. In fact, commodity prices now tend to rise when the dollar depreciates, and OPEC even uses a formula that automatically adjusts oil prices to track the average performances of the dollar and the euro.
So what should we make of all this? First, that U.S. power in international economic and financial matters is only tenuously linked to the dollar’s supremacy, contrary to appearances and to the beliefs of many. Second, that the euro is a long way from over taking the dollar. Europeans could nevertheless wield considerably more financial and economic power if they were to speak with one voice, but that seems at least as difficult for them as dislodging the dollar. |