Introduction | 6 | The Future of Global Currency

ABSTRACT

The day of the dollar is over, the era of the euro has begun-such was the view of many well-informed observers when Europe’s new joint currency was born back in 1999. America’s faltering greenback, long the dominant currency in the world economy, now faced a potent new rival. It was only a matter of time until the euro would achieve parity with the greenback as a global currency or possibly even surpass it. Typical was Nobel Prize laureate Robert Mundell, often hailed as the father of the euro, who boldly asserted that Europe’s money “will challenge the status of the dollar and alter the power conﬁguration of the system.” As Mundell’s wording suggested, much was at stake. An international

currency bestows considerable beneﬁts on its issuer; material capabilities may be greatly enhanced. For decades, the United States had exploited the global acceptability of the greenback to promote America’s foreign policy objectives. In eﬀect, Washington was free to spend money around the world virtually without limit in support of its military, diplomatic, and economic programsan advantage that Charles de Gaulle roundly criticized as an “exorbitant privilege.” But why shouldn’t Europeans enjoy an exorbitant privilege, too? With the creation of the euro, it was widely believed, the balance of power in monetary aﬀairs would soon tip in Europe’s direction. Not everyone agreed, however-and among the skeptics I may count

myself. From the time the Maastricht Treaty was signed in 1992, setting the European Union (EU) on the way to its Economic and Monetary Union (EMU), I had my doubts, ﬁrst expressed in print as early as 1996. Yes, EMU had much going for it, including a thriving economy as large as that of the United States and an array of world-class ﬁnancial markets. No one could deny the new currency’s strengths. But there were weaknesses too, structural and deep, that in my opinion were bound to limit the euro’s appeal outside the EU’s immediate neighborhood. The euro, I believed, would never be able to topple the dollar from its perch as the world’s preeminent global currency. Little that has happened in the period since the euro’s birth has persuaded me to think otherwise. In many respects, of course, the euro must be rated as an historic achieve-

ment. To merge the separate monies of some of the biggest economies in the

world was certainly no small deed. Technically, the euro’s birth proved to be remarkably smooth, quickly relegating EMU’s so-called “legacy” currencies to the dustbin of history. The new European Central Bank (ECB) experienced few diﬃculties taking over management of monetary policy for the group as a whole. Membership of the euro zone expanded from its initial eleven countries to, at last count, sixteen. And for the ﬁrst time since the era of the classical gold standard, participants no longer had to worry about the risk of exchange-rate disturbances in their corner of the world. In place of distinct national currencies, each vulnerable to the dangers of market speculation, they could all enjoy the equivalent of irrevocably ﬁxed exchange rates with their neighbors-the hardest of “hard” pegs. On the broader world stage, however, accomplishments have been rather

more modest. The dollar’s status has not, in fact, been challenged. To be sure, international use of the euro did grow in the currency’s ﬁrst years, particularly in bond markets. In short order, Europe’s money successfully established itself as second only to the greenback in global ﬁnance. But after an initial spurt of enthusiasm for the new currency, internationalization soon leveled oﬀ and has since been conﬁned largely to a limited range of market sectors and regions. Overall, sometime around EMU’s ﬁfth birthday, the euro’s trajectory eﬀectively stalled. A ceiling appears to have been reached, leaving Europe’s money ﬁrmly planted in the dollar’s long shadow. Not even the global crisis that began in mid-2007, triggered by the sub-

prime mortgage collapse in the United States, was able to elevate the euro’s fortunes. By 2008 the soundness of the world’s entire monetary structure had been thrown into question. If ever there was a moment when the euro might have been expected to come into it own, this was it. American ﬁnancial enterprises were clearly to blame for the troubles. Why not turn to EMU instead? Yet in fact the reverse occurred. Even at moments of greatest panic, market actors looked to the greenback, not the euro, for safety. Global demand for dollar-denominated assets accelerated sharply, while euro claims were abandoned. Worse, by the early months of 2010 doubts began to be expressed about the

viability of the euro itself. The catalyst was Greece, whose mushrooming sovereign debt problems threatened to overwhelm EMU’s governing institutions. Exchange-rate disturbances may no longer be a risk within the euro zone, but that did not rule out market speculation against a weak and vulnerable economy. In the EU’s own version of a Greek tragedy, policymakers bickered publicly over what to do to help Athens-a process described by one journalist as “an exercise in cat-herding.” Ultimately, with the help of the International Monetary Fund (IMF), an unprecedented “stabilization mechanism” worth nearly $1 trillion was cobbled together to stave oﬀ the possibility of default by Greece or other euro-zone countries. But by then the damage was done. Conﬁdence in EMU was at a low ebb. Some sources even went so far as to declare that Europe’s experiment in

monetary union had now failed. In a well-publicized speech in London

in mid-May, Paul Volcker-former chair of the Federal Reserve and now an inﬂuential White House adviser-dramatically warned of the “potential disintegration of the euro.” German Chancellor Angela Merkel went even further, telling her parliament that the euro-zone crisis was the greatest test for the EU since its creation. “It is a question of survival,” she said. “The euro is in danger. If the euro fails, then Europe fails.” Never had Europe’s money looked less like a contender for global status. As this book went to press in mid-2010, the fate of the euro seemed to be

hanging in the balance. My own view, which I have often expressed to my students and others, is that over the long term the euro will not succeed-but neither will it fail. It will not fail because the political commitment to its survival, in some form, simply runs too deep across the EU. Like Mark Twain, Europeans may rightfully feel that reports of the death of their currency have been greatly exaggerated. But neither will the euro truly succeed, because its deﬁciencies also are too deep. In some sense, the euro’s fate will always be hanging in the balance. One thing seems certain. As an international currency, the euro is unlikely

to break through the ceiling that it reached after its ﬁrst few years. Parity with the dollar will not be attained. The reasons for my judgment are spelled out in the essays collected together in the pages of this volume.The essays in this book, all but one written during the lifetime of the euro, divide into three groups. The two essays in Part I set the stage, describing the wider contexts in which the bilateral rivalry between Europe’s money and the greenback was to be played out. Part II focuses more narrowly on the rivalry itself and, in particular, on the deﬁciencies of the euro that in my view severely constrain its prospects as a global currency. Finally, the three essays in Part III look more to the future, contemplating what the global monetary system might look like further down the road following the stalled challenge of the euro. Chapter 1, published in the millennium year of 2000, takes a broad per-

spective on the monetary system as a whole, laying out long-term prospects for global currencies in the twenty-ﬁrst century. Particular emphasis is placed on what I call the Big Three-the dollar, euro, and Japanese yen-the three most widely used monies of their day. The essay explores how relative standing among the Big Three may be inﬂuenced by a trio of key considerations: the logic of market competition, the strategic preferences of national governments, and prospective technological developments. Analysis suggests little near-term threat to the predominance of the Big Three, although relative standing could be substantially altered by market competition, which in turn could lead to intensiﬁed policy competition among issuing authorities. Over the longer term, technological developments could lead to the development of entirely new rivals to today’s top currencies, thereby transforming the geography of money virtually beyond recognition. Chapter 2, in turn, narrows the focus to the bilateral relationship between

the United States and Europe. How, the essay asks, will the euro’s challenge to the dollar aﬀect transatlantic relations? Could monetary rivalry spill over

into a broader geopolitical confrontation between historical allies? Much depends, I contend, on how vigorously the nations of Europe choose to promote their currency’s internationalization. Europeans may certainly be expected to do whatever they can to reinforce the market appeal of the euro. But would they go further, to seek formation of an organized monetary bloc with foreign governments-a move that would almost certainly provoke determined resistance from Washington? I ﬁnd little evidence to believe that Europe is prepared to push currency competition with the United States to the point where it might jeopardize more vital political and security interests. Mutual restraint, I argue, is the much more likely scenario. What, then, can be said about the prospective market appeal of the euro?

That is the central question addressed in the next ﬁve chapters, beginning in Chapter 3 with a brief early comment of mine published not long after the Maastricht Treaty was signed. In response to those predicting a bright global future for Europe’s new money, I advised a note of caution. The greenback would not be so easily displaced, I warned. On the contrary, even within the European region itself the euro could ﬁnd itself on the defensive, given the dollar’s continuing attractiveness for many international uses. It would not be easy to overcome the greenback’s entrenched advantages. A few years later, in 2003, I spelled out my argument more fully in the third

Journal of Common Market Studies-European Union Studies Association Lecture, presented at the eighth biennial international conference of the European Union Studies Association. Reproduced here as Chapter 4, the lecture outlines four reasons why, in my opinion, the euro is fated to remain a distant second to the dollar. First is the persistent inertia of monetary behavior in general, owing to what economists call “network externalities”— essentially, the natural advantage that an incumbent currency has in oﬀering an already well-established transactional domain. The greenback’s network externalities can be counted on to inhibit any rapid switch to Europe’s money. Second is the cost of doing business in euros, which is unlikely to decline substantially below transactions costs for the dollar. Third is an anti-growth bias that I argue is built into the institutions of EMU, tending to limit returns on euro-denominated assets. And fourth is the ambiguous governance structure of the monetary union, which sows doubt among prospective euro users. Even under the best of circumstances, the chapter concludes, the euro is ﬁghting a distinctly uphill battle. Would enlargement make a diﬀerence? That is the question taken up in

Chapter 5. We know that the monetary union’s membership will continue to grow, since eventual adoption of the joint currency is a legal obligation for all of the twelve countries added to the EU since the euro’s birth, as well as for any future entrants. More members will mean an even broader transactional domain, increasing exponentially the potential for network externalities to oﬀset the natural incumbency advantages of the dollar. But outweighing that gain, I suggest, would be a distinctly negative impact on the governance structure of EMU, which can be expected to sow even greater doubts among

prospective euro users. From the start, internationalization of the euro has been retarded by a lack of clarity about the delegation of monetary authority among governments and EU institutions. In eﬀect, no one knows who really is in charge. The addition of a diverse collection of new members, with signiﬁcantly diﬀerent interests and priorities, can only make the challenge of governance worse, exacerbating ambiguity at the expense of transparency and accountability. Enlargement, I contend, will diminish, not enhance, the euro’s appeal as a rival to the greenback. New governance issues are also addressed in Chapter 6, which focuses on how the creation of the euro has aﬀected the power of participating states to cope with external challenges. Overall, the essay suggests, EMU has signally failed to enhance the group’s autonomy or inﬂuence in monetary aﬀairs. Despite the elimination of any risk of exchangerate disturbances within the euro zone, members remain vulnerable to ﬂuctuations of the euro vis-à-vis outside currencies; and, as the Greek episode in 2010 made vividly clear, the bloc has become, if anything, even more exposed to threats of ﬁnancial instability. Likewise, lacking a single voice, the group continues to punch below its weight in monetary diplomacy. The fundamental problem, I argue, lies in the mismatch between the domain of the monetary union and the jurisdiction of its participating governments. The euro is a currency without a country-the product of an interstate agreement rather than the expression of a single sovereign power. Hence EMU’s power to cope with external challenges is structurally constrained. The consequences of all these deﬁciencies are evident in Chapter 7, which

reviews available statistical information on the actual performance of the euro as an international currency over its ﬁrst decade. The numbers clearly conﬁrm the failure of the euro’s challenge to the dollar. Overall, Europe’s money has done little more than hold its own as compared with the past global market shares of EMU’s legacy currencies. After a fast start, international use broadly leveled oﬀ by 2004 and has shown little growth since then. Moreover, increases have been uneven across both functional categories and regions. The expansion of usage has been most dramatic in the issuance of debt securities; there have also been some modest increases in the euro’s share of trade invoicing and central bank reserves. But in other categories, such as foreignexchange trading or banking, the dominance of the greenback remains as great as ever. Likewise, in regional terms, it is evident that internationalization has been conﬁned mostly to countries with close geographical and/or institutional links to the euro zone-what might be considered EMU’s natural hinterland in the periphery of Europe, the Mediterranean littoral, and parts of Africa. Elsewhere, again, the dollar continues to cast a long shadow. Can Europe do anything about the euro’s deﬁciencies? Some suggestions

are oﬀered in Chapter 8, co-authored with Paola Subacchi, director of international economic studies at the Royal Institute for International Aﬀairs (otherwise known as Chatham House, London). As matters stand now, the essay asserts, the world can expect to continue living for some time in a “one-and-a-half currency system,” with Europe’s money playing at best

a subordinate role as compared to the dollar. To enhance the euro’s role, Subacchi and I argue, a determined reform of EMU’s governance structure is imperative, with emphasis on two issues in particular-exchange-rate management and institutional representation. On the one hand, Europe needs more proactive management of the euro’s exchange rate, to reduce the bloc’s vulnerability to ﬂuctuations vis-à-vis outside currencies, coupled with better coordination and surveillance of ﬁscal policies at the national level. On the other hand, it also needs to consolidate euro-zone representation in relevant international bodies and forums such as the IMF and Group of 20 if it is to be able to function as a monetary heavyweight comparable to the United States. Without such reforms to help project power more eﬀectively, we suggest, Europe will never be ready for prime time. Extending the perspective and time horizon, Chapter 9 moves beyond the

euro alone to consider the wider array of potential future challengers to the dollar. These include not only Europe’s money but also, possibly, a revived yen or even, in the longer term, an emergent Chinese yuan. The essay accepts that the global position of the greenback may be weakening under the burden of America’s external deﬁcits and looming foreign debt. The dollar can never be as dominant as it once was. But neither is there any obvious new leader lurking in the wings, just waiting to take center stage. The weaknesses of the euro are by now obvious. Other potential challengers have deﬁciencies, too, which are likely to limit their appeal as well. Most probable, therefore, is the gradual emergence over time of a fragmented global order, with several monies in contention but none clearly in the lead. We are heading, I contend, toward a leaderless currency system. Finally, in Chapter 10, I reﬂect on implications of global currency rivalries

for the broader international monetary order. The trend toward a leaderless currency system is just one signal among many that the distribution of power in monetary aﬀairs is changing, with signiﬁcant implications for the management of global ﬁnance in the future. More and more states are gaining a degree of insulation from outside pressures, enhancing their ability to act autonomously; yet few are yet able to exercise greater authority to shape events or outcomes. Leadership, therefore, is being dispersed rather than relocated and monetary power is steadily diﬀusing, generating greater ambiguity in prevailing governance structures. Increasingly, governance is coming to rely not on formal negotiation but, rather, on informal custom and usage to deﬁne standards of behavior. The result over time will be an ever greater level of uncertainty about the prevailing rules of the game. If instability and crisis are to be avoided, I suggest, a change of bargaining strategy among governments will be needed to conform more comfortably to the new distribution of power.