International role of the Euro and the developing Euro crisis
The Euro has become the second most important international currency and, although strong advantages will continuing to favor the dollar for some time, the euro is likely to further increase its international weight. This brings new opportunities but also new risks for the euro area. Moreover, EMU has created one of the largest integrated economic and financial areas in the world. In combination with the rising international status of the euro, this is making economic developments and policies in the euro area increasingly relevant for the world economy.
Globalization, particularly in the financial field, is magnifying the implications of these changes, too. At the outset there was a consensus that the euro would be well received internationally but would not match the US dollar’s dominant position. In practice, the euro quickly emerged as the second most important international currency alongside the US dollar and continues to consolidate this position. The euro has become a prominent currency of denomination in international debt markets and its role as an invoicing and reserve currency has been growing as well.
It plays an important role as an anchor or reference currency in the managed exchange rate regimes of about 40 countries. Even so, the US dollar
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In this paper, we are going to further address the matters above and discuss the Role of the Euro compared to the Dollar, gauge the Euro’s weight in third countries as well as in global financial markets, and finally give an excursion about present challenges and issues (the current Greek crisis). History of Euro On January 1, 1999 the Euro became the official currency for more than 300 million people in Europe. It was first introduced as an accounting or electronic currency in 2001 (ECU), and in 2002 became legal tender in 12 EU member states.
Within the next few months participating countries phased out their existing currencies – and for the most part the transition was smooth. Based on the market rates of 31 December 1998, the Council of the European Union set the conversion rates for one equal to: the European Central Bank (ECB) in Frankfurt controls the Euro monetary policy, while the European System of Central Banks (ESCB) is responsible for printing, minting, and distributing the currency. The Euro system is composed of the ECB and the national banks of the 12 participating EU countries.
The ECB aims to maintain stability of the Euro, ensure growth and keep inflation low. The Euro is currently the official currency in 16 countries. What are the Benefits of Euro? As regards the benefits of euro, these can be seen from two perspectives: from the perspective of the individual country and from the perspective of the euro area as a whole. The convergence process for euro area entry is aimed at ensuring that participation in the euro area is beneficial for both.
Starting with the euro area, Monetary Union represents the completion of the Internal Market in the EU, providing full price and cost transparency to the Single Market for goods, services, labour and capital. The euro has brought exchange rate stability within the area, which supports trade and enables economies of scale, thereby providing the conditions for a more efficient allocation of resources. For the ordinary citizen, the most striking advantage is of course that they no longer need to exchange currencies when travelling in the euro area.
In addition, the euro has brought monetary stability, with low inflation and a convergence of long-term interest rates to the low levels prevailing in the countries that had the highest monetary policy credibility before the euro was introduced. The main benefit of the euro for the individual country, especially for small and open economies, relates to its potential to promote trade. By eliminating exchange rate volatility and providing complete price transparency, the euro has greatly enhanced the forces that lead to economic activity to be conducted across borders.
It has been shown in a number of studies that trade integration has increased rapidly among countries that have introduced the euro, with a significant increase in intra-euro area trade and foreign direct investment (FDI). Indeed, exports and imports of goods within the euro area rose from about 27% of GDP in 1999 to around 32% in 2006. This rise in cross-border trade may to a certain extent be due to the introduction of the single currency, the increased price and cost transparency it helped foster and the absence of exchange rate risk.
At the same time, the increase in trade with the rest of the world has recently been even greater than the increase in intra-euro area trade, with the following figures showing that the euro area is very open. From 1999 to 2006, extra-euro area exports and imports of goods rose to 33% of euro area GDP from about 24%. The stronger growth of extra-euro area trade has mainly been due to the more sustained growth in world GDP, an increase in global trade integration and the very sizeable increase in trade with China, emerging Asia and the new EU Member States that joined the Union in May 2004.
Finally, a factor which may be particularly important for small, open economies is that adopting the euro may provide stronger protection against international financial disturbances. Such disturbances have often had a disproportional effect on smaller economies, raising the risks of external shocks. In sum, the introduction of the euro has been a great success, showing that clarity of vision based on sound economic arguments and determined planning and implementation can yield important results in adapting our economies to the future global challenges. The Current Economic Situation in Euro Area
There are three indicators to look into in order to have broad understanding of current economic situation of Euro area. The GDP growth. Inflation and the Unemployment rate are the key indicators and we can find comparasion between US and EU area. The Gross Domestic Product (GDP) in the Euro Area expanded at an annual rate of 0. 20 percent in the last quarter. The Euro Area Gross Domestic Product is worth 13565 billion dollars or 21. 88% of the world economy, according to the World Bank. The Euro Area (Eurozone) refers to a monetary union among the European Union member states that have adopted the euro as their sole official currency.
It currently consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. The Euro Area overall economy is the second largest, after the U. S. The above forecast from Consensus Econmics shows that Economy growth was actually healthy in 2006 and 2007 close to 3%. However in 2008 already the economy starts to slow and in 2009 turned out according to the statistics to be quite bad year in both area U. S and Euro area.
Some report came out with negative 6. 2% of U. S GDP growth and negative 5. 8% in Euro area for the fourth quarter of 2008. From the forecast, it is worth to point out that this is the first recession for the euro area since launch of euro. For the inflation, the chart show quite similar pictures of GDP growth. Of course it is normally good when low inflation, we have normally slow glowth then normally take pressure off from inflation so the prices go down and growth at least get slower.
So here we are looing at both U. S and Euro area, they come down in 2009 to much lower leverls of inflation even possibly to negative inflation or deflation in U. S according to the forecast in 2009 year. What is interesting note here in 2008, prices and inflation was quite high due to the shock, we had, oil price shock and even more general high price for lot of commodities from natural resources and etc. So that is all come back down now and global demand and growth has slowed. Therefore, it is expected to have low inflation through 2009 and 2010. Finally, third indicator is the Unemployment rate.
The forecast of unemployment rate arose for both regions in 2009 and 2010. This is to be expected because economy was slowing very sharply. However it is sign of good news for the Euro area that unemployment rate has been declined in recent years, as a result of economy growth and economy reform. For example, 16 millions of job was created in the first 10 years since Euro was launched. The International Role of the Euro in International Debt Markets One question that arises when looking at the International Role of the Euro is how the weight of the Euro can be measured.
In international debt securities markets, use of the euro occurs in three cases. In the first case, international use of the Euro occurs when an instrument denominated in Euros is issued by a non European Union resident. Who is holding the instrument is not important. In the second case, international use occurs when an instrument is held by a non European Union resident. This is also the most important and frequent case as we will see later. Lastly, use of the Euro occurs when an instrument is both issued and held by a non European Union resident.
Until mid-2008 the composition of Euro-denominated debt by residence of holder and issuer showed, that the internationalization of the Euro was still relatively small compared to the domestic markets (European Central Bank, 2009). Instruments issued and held by European Union resident accounted for 74. 3% of total issuance of Euro-denominated debt securities. Within the international use of the Euro, the most important segment, as mentioned before, is the issuance of instruments by EU residents that are then held by non EU residents.
This category accounts for £2. 118 billion or 12. 5% and is about a third larger as the second important international use, issuance of instruments by non EU residents which are then held by EU residents (£ 1. 456 billion or 8. 6%). The least important is the case of issuance and holding of instruments by non EU residents, which only accounts for £ 791 billion or 4. 7%. Another way to measure the importance of the Euro is to analyze the currency composition of the international debt securities markets. When carrying out such an analysis, two indicators can be used.
The first is the “global measure”, which is the total outstanding amount of Euro-denominated debt securities that also includes domestic issuance. The second is the “narrow measure”, which is the outstanding amount of Euro-denominated debt securities issued by non European Union residents. This measure can be seen as the more important because it strictly includes only international transactions, but opinions differ since a globally important currency should also be measured by its domestic market (which the global measure includes).
When looking at the timeline and the change of the share of the Euro in the international debt securities markets composition, one can see that when the Euro was introduced in 1999 as a book currency it instantly took about 21% of market share (narrow measure). Until mid 2005 this share grew continuously to 35%, its maximum (Amato, 2005), after which it was decreasing again. Recently in 2008, the share grew again in spite of the financial crisis.
The global measure on the other hand only shows a steady rise from about 26% in 1999 to close to 30% until 2008 (Bank of International Settlements, 2010), which can be explained by the much larger amounts and thus leaving the global measure with a smaller volatility than the narrow measure (European Central Bank, 2008). The 15% market share rise (narrow measure) shows that the Euro after its already successful introduction became even more important regarding strictly international transactions. The global measure only shows a 4% market share gain and does not display the importance as clearly as the narrow measure.
The current share of the Euro is at 32. 2% or £3. 098 billion by the narrow measure and with the global measure at 29. 5% or £24. 601 billion (European Central Bank, 2009). As a conclusion, the Euro captures a third of market share in the international debt securities markets. Although the Dollar is still the most important currency (44% market share, narrow measure), the Euro has in 9 years reached a strong position and is by far the second most important currency in these markets (the Japanese Yen following third with only 6. 8% market share, narrow measure).
Only looking at the currency composition does not show the whole picture though. A geographical breakdown of the international use of the Euro in international debt securities gives a more comprehensive understanding. As can be seen, the Euro has a very strong regional importance in central and eastern European EU countries and large non Euro EU member countries (Denmark, Sweden, and UK), as well as in North America and to a certain degree in Africa (European Central Bank, 2009). But in Asia and the Pacific region, concerning offshore centers, Latin America and the Middle East, the Euro plays only a minor role in international transactions.
This shows, that although the share of the Euro by the global and narrow measure captures almost a third of the international debt securities markets, the use is more limited geographically to the EU area and neighboring countries and regions than suspected with the measurements mentioned before. Turning now from the international debt securities markets to the international loan markets, one has to notice a different currency distribution. The share of the Euro in these markets has since 1999 been around 20%, leaving the Dollar at around 55%.
The Yen again is the third strongest, but lost market share compared to the Euro since 2000 (European Central Bank, 2009). When looking at the actual amounts, we can see a steady rise until 2007, after which the total amount in the loan markets saw a drop due to the financial crisis. Also, generally greater risk aversion, an uncertain economic outlook and shortage of funding were drivers for the development in 2008 (European Central Bank, 2009). The currency distribution, though, stayed roughly the same for the Euro, Dollar, yen and others.
The Euro’s role, thus, is not as important as we saw in the international debt securities markets, accounting only for about one fifth of the volume. The international deposit markets were also undergoing similar developments as the international loan markets. In 2008, they were also hit by a decrease in total volume. The Euro’s share was higher than in the international loan markets, at close to 30% until 2005. After that, the Euro lost market share until 2007 to the Dollar, which increased from around 53% to about 60% in 2008. In 2008 the Euro also showed a small upward trend, recovering to around 22% (European Central Bank, 2009).
The International Role of the Euro in International Trade The primary goal of introducing the euro nearly ten years ago was to achieve a higher level of economic integration within the European single market and to promote both economic growth and stability1. The US dollar still is the dominant currency in international trade transactions, but the euro has gained substantial ground since its intention ten years ago. The role of the euro has expanded its influence as a vehicle currency2 within the process of trade among intra- and inter-national regions.
Coupled with the introduction of euro aimed at the greater economic benefits in general, its anticipated effects in terms of trade gains are to intensify the commercial relations between member countries through expanding the volume of trade. By promoting a deeper integration resulted in an elimination of barriers to trade such as reducing the exchange risks and the costs of changing currencies within the European Union,3 many previous literatures continued to find large trade effects from currency union.
According to the table given by Faruqee’s IMF Working Paper, the trends in Euro area goods and services has been underscored and proved a pattern of positive growth in last ten years. It is definite that euro area countries have continued to determine the choice of currency in which international trade is invoiced as the euro and expand the use of the euro with countries outside the euro area; yet how about the trade involving third countries which are outside the euro area?
Since a number of studies has diagnosed and proved with the positive effect of the euro on trade in terms of the amount changed before and after, it is important for now to focus instead on how the currency actually affects the trade4. Interestingly among many determinants of currency denomination of trade, the euro’s share in the settlement and invoicing of merchandise trade has greatly been determined by a geographical factor5. The intriguing aspect of the international role of the euro especially on the global trade is that the role maintains a strong regional pattern.
Thereby with the euro zones, the closer a nation is geographically located from the euro area the easier it involves in using the euro as a currency of transaction. According to the ECB report of 2009, it is noted that even within the third countries outside of euro-zone, the levels of euro usage as a trading currency are different according to the geographical reason which also closely relates to the issue of the existence of network externalities in international trade.
The network externalities typifies the effect that one user of a good or service has on the value of that product to other people. In other words, the value of a product or service, in this case the euro as a transaction currency, amplifies as more people use it when the network externalities present. For example, the share of the euro in the invoicing or settlement of trade significantly increased in case of Slovakia which is being geographically close to other nations using the euro.
On the contrary, however, Cyprus which rather has more strong trade relations with the United Kingdom denoted that its relatively low share of the euro as the invoicing and settlement currencies is due to its unclose geographical location to the euro area. The EDB reports of 2009 concluded the reason for this pattern for Cyprus is that the adoption of the euro alone was insufficient to trigger a shift in the currency denomination of trade flows with non-euro are countries to the euro.
