By Henri Erti. Originally published on 2013/02/03

Kick the can down the road

The current global financial crisis has ironically produced a rather surprising and benign unintended consequence. Since financial globalization has shaped the world’s macroeconomic paradigm after the Bretton Woods system, the current status quo has come under fierce criticism. More specifically, the dollar’s“exorbitant privilege” is no longer considered to be a granted right, in particular after the recklessness of U.S economic activities prior to the financial meltdown has become evident. Furthermore, the evolution of the international monetary system has produced a multicurrency system, in which  emerging and existing strong economies are armed and ready to challenge the dollar as the de facto global currency.

Euro Rises Up

How about the Euro? Euro-zone exports, mostly generated by the German economy, are twice as large as the U.S exports. Furthermore, due to the common market where the transaction and conversion expenses are in the past, countries and companies may settle trade payments using the very same currency and eliminate the risks of exchange rate fluctuations. During the recent global financial crisis when the emerging economies have accumulated vast amounts of reserves to artificially set the value of their currency, the Euro-zone countries have the privilege to avoid such fluctuations and volatilities. Therefore, the net-work value of the Euro has become comparable to the dollar, given that the external demand for Euro increases due to its potential strength.


A competitive and credible reserve currency needs to have a solid central bank behind it. The Federal Reserve is the bastion for the dollar, where inflation and interest rates are relatively well controlled to support the international monetary system. Consequently, during the financial crisis, investors rushed to U.S T-bills to protect their money from the financial contagion. At the same time, the ECB’s perhaps politically unpopular decision to purchase government bonds from the “junkyards” exhibited similar firm determination of the Euro-zone’s ability to adjust their unbalanced fiscal order. Certainly if the markets had lost faith in the Euro as a strong and safe international reserve currency, the Euro would not represent 28 % of the world’s total accumulated reserve currencies or 31 % of all international bond issues[1].

Still so Far Behind

At first quick glance at the Euro, one might wonder why it is not performing to its potential. There are various reasons for such a puzzling situation, but certainly the first and foremost is the fact that the Euro is a currency without a state. Not backed by a single government and rejected by certain members of the European Union, the dream of the Euro being the “chosen” dominating currency is quite frankly unforeseeable. The inability to discard the myopic political differences and the collective reluctance to share the burden of the bail-out packages have prevented the Euro to rival the dollar as a serious alternative for a new global reserve currency within the framework of the new world order. Secondly, in order to become the “banker of the world” a country has to have economic growth. Unfortunately, the European Union will not enjoy growth in the near future after falling back to a recession at the end of the last year. Although the GDP growth of the United States is similarly minuscule, the current IMS structure allows the U.S to run current account deficits because the U.S must provide stable liquidity to the world markets. Such paradox is better known as the Triffin Dilemma.

What Can Be Done?

The Euro may in the future rise above its contenders. Given the geographical expansion of the EU, the theory of optimal currency area applies more to the Euro than to any other currency bloc. As the number of countries increases in a given area, the volume of trade subsequently increases as well. Therefore, if the number of currencies decreases due to integration, the economies of scale deriving from one currency would generate sufficient benefits, which encourage other countries to accumulate the very same currency to make necessary adjustments in their balance of payments. Secondly, if the Euro-zone succeeded in generating adequate institutional reforms, such as providing the ECB more power in overseeing the fiscal prudence of its members and enhancing the competitiveness of the common market, the credibility and probability of the Euro becoming an influential currency in the new international monetary system will be higher. But for now, the “exorbitant privilege” of the dollar prevails.

Data used in this blog has been largely extracted from Barry Eichengreen’s academic work.

Author serves as the EST Ambassador to Croatia

[1] Eichengreen, 2011.