Emergence of Euro

A challenge to global dominance of dollar

With the dawn of the year 1999, a new currency cold was born when eleven European countries signed away their sovereignty over monetary policy in Brussels, capital of the European Union (FU). They also entrusted the Frankfurt-based European Central Bank (ECB) with the freedom of setting interest rates. The occasion was celebrated by the jubilant Belgians in Brussels with mass balloon launch and champagne toasts. The eleven out of 15 members of the EU, who signed for the arrangement, are: Austria, Belgium, Finland, France, Germany, Italy, Ireland, Luxembourg, the Netherlands, Portugal and Spain. The four members of the EU, Denmark, Sweden, Britain and Greece, preferred to remain outside Italian spokesman Carlo Clamp described it as the first decisive step towards the political union of Europe, while Charles Mc Creevy of Ireland said, “It is an experimental move and one cannot say that at will be an outstanding success.” Werner Muller, Economy Minister of Germany referring to the absence of Britain, said: “Absence of potential members like Britain may endanger our success.”

                At present, one euro is worth 6.69957 French frames. Although euro currency notes and coins would not be made available to the people now, for cheques, bank accounts, credit cards, company accounts, bills and stock market prices, euro can be immediately used. The eleven euro-zone countries will have a fixed conversion rate against their national currencies and they have agreed to limit their national budget deficit within three per cent of GDP. Seven-euro currency notes of denomination 500, 200, 100, 50, 20, 10 and 5 euro and eight coins of 2 and 1 euro and 50, 20, 10, 5, 2 and 1 cent will be made available for circulation in the coming three years. So, in near future, Euro will, at a stroke, become the world’s second largest country, next to dollar. It is now a matter of whether and when it might challenge the dominant role of dollar in the world’s financial system.          

                As far as the economic matter are concerned the Euro II countries are a match for the United States in 1997, the combined GDP of the Euro II countries was dollar 65 trillion, which is very close to the US GDP of dollar 8.1 trillion. In the same year, them share of trade with the outside Euro-Zone was 19 per cent of global trade, while that of the US was 17 per cent. In fact, the emergence of dollar as a currency for international trade and investment landing to its present dominate role in the international finance market is far biggest than American’s relative share of global trade would suggest. Roughly half of the world’s trade is now in voiced in dollars and almost all commodities are period in dollars. A survey by the Bank for International Settlement has revealed that the dollar future in at least 87 per cent of all foreign transactions, over 45 per cent of the cross holder Bank’s loan are dollar are denominated and almost half of the world’s foreign –held bank deposits are in the dollars. In 1997, almost 57 per cent of the world’s reserves were in dollar.

Today, America drives several benefits from dollars globally dominant role. Firstly, profits earned from its monopoly issues or notes and coins for its earning as seignorage from dollars held abroad and this canning is of the order of 0.1 per cent of its GDP, or nearly $ 8 billion per year. Secondly, earning as liquidity discount on government debts in the bound market Richard Portes of the London Business School and Helene Rey of the London School of economics have estimated that this earning is nearly equal to that from seignorage and lies between $ 5 billion and $ 10 billion. Thirdly, the biggest advantage that American gains from dollars predominance is its ability to finance its current account deficit in its own currency. Charles de Gaulle once complained that the exorbitant privileged of dollar enable the united State to dominate over foreign countries free of charge “America might have far more difficulty in running a huge current account deficit if the dollar were not the international currency of choice”, says Portes. “For example if Europe emerges as a strong and stable currency, America will have to pay its deficit to EU in Europe”, he adds.

There is a positive indication that euro will be a strong and stable currency as it will eliminate intra-European exchange rate risks.         

So the arrival of Euro might threatened America’s ability to continue leaping such benefits as stated above and its depends on how quickly Euro will be able to establish itself as an international currency and play its global role. The optimist camp hopes Euro will be a strong and stable currency and will give the dollar a run for its money. It is very likely that many investors diversify their portfolios into euros and this will happen very quickly. The other, to some extent sceptics camp, believes euro will need to establish a track resold between the investors move into it, and hence dollar’s dominance may continue for several decades “Starling maintained its status as a globally dominant currency long after Britians economic huge money was over”, they argue. But the general belief is that such a prediction may not prove true, as toady’s capital market has become very fast as compared to what it was 40 or 50 years ago so, Fred Bergsten, Director of the Institute for International Economic, says. “It will push Euro up against the dollar very soon”.

Richard Portes and Helene Rey believe that the determinate factor of Euro’s future will be the cost of using the euro in foreign exchange and security markets. “If these costs are lower, euro will be more attractive as an International currency and for denominating trade. If Britain joins the euro- zone, the challenge to dollar dominance could come quite fast”, say Portes and Rey. In fact, there is a positive indication that euro will be a strong and stable currency since it will eliminate intro European exchange rate risks.

The most dramatic effects that will follow the appearance of euro as an international currency are-----firstly, much of what is now external trade, will become intra-euro trade for the euro-zone nations. Hence the national central banks of these countries will try to form their dollar reserves. This excess dollar reserve may be to the tune of 50 and 230 billion. Secondly, the third world countries, having good trade relations with the euro-zone, will also want to hold more euro reserve and thus a large amount of dollar reserve will change portfolio into euro. It is apprehended that quite a major portion of the total dollar reserves, roughly estimate at about 775 billion, of the central banks of these countries will be available in the money market for changing portfolio into euro very soon. This will create a downward pressure on dollar leading to a sharp fall in its exchange rate. America in burn would be forced to reduce its current account deficit of 2.1 per cent of GDP. This will also lead to a sharp rise in the exchange rate of euro against dollar.

According to Portes and Rey, all these effects will make nearly $700 billion available in the market for sale leading to about 40 per cent fall in price of dollar. Today, the third world countries including India have to pay their debt service and debt repayment in dollar. A 40 per cent fall in the exchange rate of dollar will reduce foreign debt of all these countries at least by 40 per cent, and hence the emergence of euro will virtually be a boon for them.