Give The Euro Greater Currency.
Last January, the leaders of East Timor, or, just released from Indonesian rule, made a decision that had a significant impact on the world of global finance. They chose to adopt the U.S. dollar as their currency, rather than the euro. As a former Portuguese colony, East Timor was leaning toward the euro--the successor to the Portuguese currency, the escudo. But the dollar ultimately proved more attractive.
Europeans appeared indifferent to East Timor's decision. That is a mistake. Actively encouraging "euroization"--the adoption of the currency by non-European countries--ought to be a policymaking priority on the continent. Euroization will play an important role in cementing the global importance of Europe's new currency.
As everybody readily acknowledges, establishing credibility is the great challenge for the European Central Bank (ECB). The ECB has devoted much thought to the question of how to make the euro more credible to traders and suspicious private investors. Up until now, the benchmark for measuring the euro's strength has been the exchange rate of the euro relative to the dollar and the yen. That measure has indicated that the euro was in "trouble."
But, in my view, the degree of euroization in countries outside the EU would be a much better measure of the euro's overall acceptance. We will know that the euro has widespread credibility if people living outside the euro-zone voluntarily adopt it as their currency. Such a vote of confidence would be the clearest sign that the ECB is succeeding in creating a secure monetary standard.
A surprising number of countries today are searching for monetary stability outside their borders. Go to Latin America. Maybe you'll spend a few pesos and bolivars. Or maybe you'll just spend U.S. dollars, the dependable currency from way "north of the border." More and more Latin Americans are using the dollar in place of their own national currencies, sometimes with the support of their monetary authorities. What is going on? It is a movement toward accepting the obvious--or reducing risk. The obvious is that the Latin American economies are closely tied to the United States, and it is simpler to do business on the basis of a single currency. And in Latin America, independent monetary institutions have proven all too often to be prone to inflation. So why not simply use the more trustworthy cash printed up north? That is really all that is behind the international trend toward "dollarization."
The United States is by no means a disinterested party. It earns $12 billion to $15 billion each year from sales of its currency (the value of the bank notes that leave the country every year). The Federal Reserve estimates that foreigners hold between $250 billion and $300 billion worth of its banknotes. That amount finances the U.S. trade deficit for an entire year, even at today's high levels. So the United States is able to obtain goods and services by simply giving foreigners pieces of green paper that cost pennies to print. More important even than the material benefits, foreigners' desire to hold dollars is the ultimate sign of confidence in the U.S. economy.
There is no reason why the United States should monopolize these benefits. At present, however, Europe has but a small share of the world's currency market. The chief European competitor to the dollar traditionally has been the German mark. The Bundesbank estimates that between DM 65 billion and DM 90 billion is being held abroad--perhaps 20 percent of the U.S. dollar holdings. Nothing indicates more clearly the extent to which the dollar is the international currency than the fact that it is the currency of choice for investors whose own governments cannot provide a stable currency.
But the euro has the potential to change this situation drastically. Many of the countries that use dollars are on the periphery of Europe--the CIS countries, the Balkan nations, Romania and Bulgaria. People in these countries trade more with Europe than with the United States. They would prefer to use a European currency for such transactions. Using dollars exposes them to exchange risk, since the value of the dollar in relation to European currencies is always uncertain. Until now, there was no single European currency that could fill this role. In the age of the euro, however, there is an alternative. These countries are strong candidates for euroization.
True euroization will not occur until there are coins and notes. So don't look for it before 2002, when euro-zone members are to withdraw their own currencies from circulation and replace them with the euro. Once euros begin circulating, the currency will have some impressive advantages over the dollar. First, for countries that trade primarily with Europe, using the euro allows everybody to agree on a single currency. That is why Latin American countries find the dollar so convenient. Second, euros will be available in larger denominations--200 and 500-euro notes--than the dollar, which stops at the 100-dollar bill. In many places, "parallel" currencies such as the dollar or euro are often used in place of banking transactions. So large denominations, which make major transactions easier, are important. And finally, the euro bills will be state-of-the art examples of currency, especially with regard to security. The euro notes are designed to incorporate elements such as diff active and reflective foils and machine-readable features that are not used in even the new U.S. currency. So forgery is less likely to be the problem it is with the more traditionally designed U.S. currency.
Europeans--especially Germans--tried in the past to prevent their currencies from being circulated widely abroad. The Bundesbank's long-time argument was that the overhang of currency held abroad could affect monetary aggregates if the foreigners decided they didn't want to hold it any more. But aside from the fact that it is difficultmif not impossible--to prevent foreigners from adopting a parallel currency, actual problems have not occurred. In fact, the demand for marks outside of Germany has been extremely stable. Coins and notes account for only a small 7 percent of the M3 on euro territory. So even if a large portion of those notes and coins were held abroad and suddenly found their way back home, the impact on the money supply would be slight.
The United States--which has a much larger portion of its currency circulating abroad than Germany--has never experienced such problems. Germany's inflation fears may have been justified in the past due to the country's relatively small size. But such worries appear much less realistic for the euro given the breadth of the euro-zone. Even a large currency overhang would have only a small potential impact on the money stock of all eleven euro-countries. Allowing foreigners to use the euro is a part of the process by which Europe must "grow up" and become, with the United States, a leader in the world economy.
The EMU countries should therefore welcome euroization. First, for the straightforward reason that it is a money earner. Given the profits earned by the U.S. Fed, the ECB could expect to generate revenues of at least five billion euros per year. That would be a small but pleasant surprise for the treasuries of the EMU countries. More important, however, is the question of credibility. The driving force behind dollarization is the credibility of the Fed compared to the national monetary authorities in places such as Latin America. In some countries, such as Argentina, the monetary authorities are considering official dollarization precisely because it allows them to share the Fed's impressive monetary credentials. Fed Chairman Alan Greenspan views dollafization favorably in this context. He has stated that foreigners' preference for dollars comes from their faith in U.S. monetary institutions. Surely Wim Duisenberg, the head of the ECB, would like to be able to make a similar statement.
Martin Hafner is Chief Economist at Hypo Vereins-bank.
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|Title Annotation:||Euro to gain credibility by more circulation abroad|
|Publication:||The International Economy|
|Date:||Nov 1, 2000|
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