Since the advent of the Bretton Woods System when the dollar was issued as an international reserve currency, Europeans especially the French, decried ‘le privilege exorbitant’ of the US. Indeed, the exorbitant privilege was used and misused throughout the 1960s, to pay for Johnson’s New Society and for the Vietnam war. This currency power has many benefits, so with the start of the monetary cooperation in Europe, the EU wanted something for itself like the dollar, so it created the euro. Hence, the euro is used widely as a reserve currency entailing special benefits for the Economic and Monetary Union (EMU).
What makes a currency a reserve currency? Political and economic factors determine such a role: a country’s share in world output and trade, invoicing trade in this currency and be a role in official reserves are in this calculation, like stability (internal and external) and network externalities. The establishment of deep financial markets for the attraction of a reserve currency are likely to enhance such a role. So is London City the deepest market for euro’s and not Frankfurt, though the former is not part of the EMU unlike the latter.
What benefits does it offer? The dollar as an anchor allows the US more monetary autonomy and profits from seigniorage. It can also be used to further foreign policy goals, such as financial blockade that done to Iran before the deal.
Since the conception of the ECB and EMU, it does not have a stated goal to internationalise the euro but because of the size and the development, financially like the US, the euro started out in good standing for future internationalisation. But the dollar remains ‘primus inter pares’.
Countries with the aspiration of joining the euro one day tend to attach their currency to the euro, as stipulated by the convergence criteria of the EMU. Indeed, countries like Montenegro also tend ‘euro-nise’ with neighbouring regions like the Middle East and Northern Africa likewise using the euro more than the dollar. So it is occasionally believed by conspiracy theorists that the US invaded Iraq because Sadam Hussein wanted to denominate its oil reserves in euro’s and not in dollars. As a matter of financial policy, developing countries like China and Brazil are also diversifying away from dollars to euro’s, but because of fragmentation of financial markets in the EMU, the dollar remains the most important currency in the world with the euro stabilized as 20-25% dominance of financial markets.
To further internationalizing the euro and becoming a threat for the dollar, some steps are further required: Banking and Capital Markets Union are required to counter the fragmentation of markets, the EMU has to issue something like Treasury-bills, called Eurobonds. Eurodebt markets need to be segmented and administrative and legal systems need to be Europeannised. Banking and Capital Markets Union are steps in the right direction but supervision remains foremost a national responsibility. The chances that the pound joins the euro are over since the referendum regarding the UK withdrawing from EU membership. Currently, London Markets will be the biggest Euromarket outside the Eurozone.
Besides the domination of the dollar, the eurozone has some financial problems with China. Similar to the US, it has accused China several times that it is a currency manipulator, undervaluing the renminbi (RMB) vis-à-vis to the euro.
This has some serious implications as the weaker currency has the advantage to export more to stronger ones, enhancing its market power and market share in foreign markets. This weakens the industry-base in Europe because its products become more expensive on foreign markets (China). However, with the recent sovereign debt crisis, Chinese exports to the EU have stalled. With complaints before the IMF and the WTO, the RMB has appreciated against every major currency., wrecking its own economy.
On the other hand, the crisis cemented the rise of China. Being out of cash, and highly in debt, many governments called for help to the Chinese officials. Indeed, the Chinese had a participation to the EFSF. The European Commission has also been defeated by the Chinese over the dumping of solar panels on European markets because of the divide, conquer the policy of China towards Europe. In the mean time, before launching an internationalisation policy of the RMB, China remains dependent on euro’s and dollars.
Within the IMF, a common criticism is the over-representation of Europe. At a G20 summit, countries pledged to diversify in the IMF towards more developing and emerging market countries.
However, European countries continue to resist implementation. So a compromise was made whereas emerging markets get more quota share (means of and voting rights in the IMF). But the US Congress has not yet ratified the changes to the IMF, preventing it from happening.
To come towards more unification and counter the criticism, the Five Presidents Report called for a unified representation in the IMF, by 2025 at the latest whereby the Eurogroup president should represent the EU at ministerial level. Indeed, the EU has representation with the IMF (EURIMF) where it coordinates EU countries to speak with one voice at the Executive Board. It is established like the representation with the WTO where European countries are represented but don’t speak individually, hence, the agreement in the TFEU that the EU does everything on foreign trade. The EU wants one ambassador for the EU with the IMF.
The exorbitant privilege of the US has not ended because of the euro. The euro still has a long way to go to become the anchor in financial markets worldwide. Its trajectory is further hampered by its woes in the sovereign debt crisis and by the London City. However, it is predicted that big key players are moving away from London towards the euro area, enhancing the EMU’s fragmentation in financial affairs, but this not very clear.
An international currency like the euro has some hard and soft power benefits, however to unleash full power, the EU has to unify more. This would shield the euro area from economic troubles but besides the Five Presidents’ Report, the Eurozone does not have a plan to develop the EMU further. This has been awarded by criticism from the Commission but also by other European countries that don’t want to join anymore.