Preface: Context and Purpose of the Paper

This issues paper was commissioned to the Elcano Royal Institute for International and Strategic Studies (the ASEM Task Force secretariat from Europe) by the Task Force at the end of its first meeting in Madrid on May 6, 2003. This request called for the paper to be submitted sometime before the second Task Force meeting scheduled for September 9, 2003 in Tokyo at the Institute for International Monetary Affairs (the Task Force secretariat from Asia).

Following the mandate laid down for the Task Force by the ASEM 4 Chair’s Statement (with its explicit suggestions for particular issues to be explored), the Task Force decided to include among the many topics for its future consideration “the creation of a Eurobond market in Asia and the use of the Euro as an international currency.”[1] In this regard, the Task Force commissioned an issues paper on the further development of Asian bond markets (including possible use of the euro) from the Institute for International Monetary Affairs (IIMA), as well as this paper on the internationalisation of the  euro from the Elcano Royal Institute.[2]

The purpose of the paper – conceived of as a complement to the IIMA’s contribution – is to provide a useful point of departure for the Task Force’s deliberations in this realm. To this end, the paper begins by outlining the recent evolution and current state of the process of euro internationalisation. It then moves on to analyse the key obstacles to further euro internationalisation, the challenges this process is likely to face in the near future, some promising strategies and policies that might facilitate it, as well as the potential costs and benefits of continued euro internationalisation. Finally, the paper explores the challenges and opportunities that further euro internationalisation may imply for Asia, including options for mutually beneficial collaboration in related policy and issue areas between Asia and Europe within the ASEM context.


The most recently available data suggests that the international role of the euro has grown since its inception as the European Union’s single currency.[3] Nevertheless, for a variety of reasons, progress towards a more prominent international role has been only gradual. No significant changes have yet been documented (although anecdotal evidence is beginning to become more common) with respect to the euro’s presence within official reserves or its use in foreign exchange markets.[4] On the other hand, use of the euro appears to have increased noticeably in trade transactions and significantly in global debt securities markets.[5]

The latest evidence also suggests that the international role of the euro retains a strong regional focus. Internationalisation of the euro has been most significant in countries neighbouring the Euro zone. This phenomenon suggests that the international role of the euro may be complementary to other phenomena for which distance matters, such a trade and institutional linkages with the European Union.[6]

The euro’s role in third country exchange rate strategies is particularly evident in central and eastern Europe and its role in the supply of foreign currency-denominated securities is most significant in economies in the broad geographical vicinity of the Euro zone. Likewise, the euro’s role as a vehicle currency in foreign exchange markets, and as a currency substitute for other national currencies in circulation, is mainly confined to countries neighbouring the Euro zone, where the euro has taken over the previous role of the German deutschmark.

Furthermore, demand for most euro-denominated securities continues to come from Euro zone investors themselves. This contrasts sharply with the international role of the dollar which is still underpinned by demand for US dollar-denominated assets from outside the US (particularly Latin America, Asia, Russia and the CIS countries).

At first glance, therefore, what might be interpreted as only limited progress in euro internationalisation would seem to contradict the predictions of some analysts and observers that the euro would rapidly take on an international role much more significant than that corresponding to the sum of its legacy currencies and quickly challenge the hegemony of the US dollar.  Despite this modest early evolution, however, there is nothing to suggest that euro internationalisation will not continue, or that its progress might not even intensify in the short and middle run. Indeed, there are a number of areas where private market actors or official policy might stimulate further significant inroads in the process of euro internationalisation. Beyond current European policy efforts and future initiatives, it is also possible that Asian private and public sector actors, for example, could provide key stimuli for such developments (see Section 5 below).

Recent Evolution of Euro Internationalisation

a)   International Debt Securities
The supply side
In a few short years, the euro has generated the second largest bond market in the world. This development has established a significant role for the euro as an international financing currency. The euro’s share in outstanding international debt instruments issued by non-Euro zone residents was 29% by the middle of 2002 (compared with shares of 44% for the US dollar and 13% for Japanese yen), up from 26% at the end of 2000 and 10 percentage points higher than the total share of the euro’s legacy currencies at the end of 1998. Nevertheless, these figures reflect only the narrowly-defined stock of international debt securities.[7] Using the broader definition of international debt securities (including debt instruments issued by Euro zone residents but targeted for international markets), the euro’s share of total stock stood at 39% by mid-2002 (compared to a 44.5% share for the US dollar), up from 34.5% at the end of 2000.[8]

In terms of flows, by mid-2002 the euro accounted for 40.5% of the broadly-defined flow of international bonds and notes (up from 35% in 2000 4Q) and 36% of the broadly-defined flow of international money market instruments (up from 32% in 2000 4Q). According to the narrow definition (including only issues by non-Euro zone residents), the euro accounted for 31% of the flow of international bonds and notes (up from 29% in 2000 4Q) and nearly 20% of the flow of international money market instruments (down slightly from 21% in 2000 4Q).[9]

The international use of the euro by commercial banks for financing purposes (including cross-border deposits in foreign currency and international securities issued by banks) has also continued to increase.  The euro’s share in international bank liabilities reached nearly 24% by the end of March 2002, up from 22% at the end of September 2000, and 6 percentage points more than at the end of 1998.[10]

The demand side
Nevertheless, as an investment currency, the euro lags further behind. Most buyers of euro-denominated debt instruments remain Euro zone residents. A survey compiled last year by Capital Access International revealed that the euro’s share in the portfolios of funds under management in the US and Canada was only 0.4% in mid-2002 (up only slightly from 0.3% at the end of 2000), suggesting that investors in North America had not yet entered the euro market in a significant way. On the other hand, in a parallel survey of the portfolios of funds under management in non-Euro zone Europe (including the UK, the Nordic countries, and central and eastern Europe) the euro’s share was 34% (up from 30% at the end of 2000), corroborating the thesis that euro internationalisation has so far been concentrated in the immediate vicinity of the Euro zone. In particular, the role of the City of London has become quite significant, where over 50% of the over-the-counter activity in secondary markets for international bonds is in euro-denominated securities.[11]

Beyond debt issues, however, other facets of the euro as an international investment currency have experienced significant progress. The share of the euro in international bank assets (cross-border loans, local loans in foreign currency and international securities held by banks) was 24% by the end of March 2002, up from 22% at the end of September 2000. This represents an increase of 8 percentage points since the beginning of Stage Three of EMU and is 6 percentage points higher than the legacy currencies’ pre-1999 share. This compares with current shares of 52% for the US dollar and 11% for the Japanese yen.[12]

Euro area equity holdings, according to the most recent data available at the end of 2000, accounted for 25% of the equity portfolios of a small sample of major global asset managers (compared to 50% for the US dollar and 11% for the Japanese yen).

It is quite plausible that the initial reluctance of non-residents to purchase euro-denominated assets has been due to the exchange rate depreciation of euro during the first three years of the currency’s existence (1999-2001).[13] This situation could change soon, as the Euro has significantly appreciated since the middle of 2002. Data for 2003 could therefore begin to reflect a change in investor attitudes, underpinned by a renewed sense of credibility driven by recent euro appreciation.

b) Foreign Exchange Markets and Trade Invoicing
As a vehicle currency in foreign exchange markets, the euro’s progress thus far has been modest. The euro’s share in global spot trading accounts for just over 20% of the whole, compared with the deutschmark’s 15% in 1998. While this share remains lower than the 26% enjoyed by the sum of the euro’s legacy currencies, it is nevertheless widely accepted that this decline has been due to the statistical effect of the single currency eliminating the trading volumes of the 12 legacy currencies. In any case, the US dollar remains the world’s dominant vehicle currency with a share of nearly 50% of global spot trading, while the Japanese yen’s share has remained constant around 13%. The situation for swap trading is roughly similar. Again, the most recent data shows that the euro has taken on a vehicle currency role among the Nordic countries and (following the deutschmark) in central and eastern Europe.[14]

As a trade invoicing currency, the euro now accounts for approximately 50% of all European trade. The most recent estimates put the euro’s share as a vehicle for total international trade at as much as 25%, compared to a roughly 50% share of world trade which is invoiced in dollars. This euro share has been increasing for trade in both goods and services among the Euro zone countries for which data is available (Belgium, France, Portugal and Spain), in Eastern European countries (Poland, Bulgaria) and Japan. Euro invoicing for EU imports from Japan increased from 40% in 2000 to over 52% in 2001, while euro invoicing for EU exports to Japan increased from 18% to 29%.[15]

Nevertheless, key commodities such as petroleum continue to be priced and paid for in dollars, despite that fact that 45% of the total merchandise imports of the OPEC member countries come from the Euro zone.[16] There have been some signs that this might soon change, as certain countries – generally regimes which have had adversTimes New Roman relationships with the US (ie, Iraq, Iran and Venezuela) – have either switched the invoicing of their oil exports from dollars to euros or have seriously contemplated such a move. Indonesia has also recently been reported to be considering such a policy change.[17] However, until the UK and Norway switch the currency denomination of their marker Brent crude to euros, it is unlikely that enough momentum will be achieved to stimulate a euro shift within the pricing and payments infrastructure of the international oil industry.

c)  The Euro as a Reserve Currency
At the end of 2001, only 13% of official holdings of foreign reserves were held in euros, whereas 68% were held in US dollars and 5% in Japanese yen. These shares have remained more or less constant since the introduction of the euro. Since 1992, the major changes have implied a greater share for the dollar (55.3% in 1992 versus 68.3% in 2001) and an eroding share for the yen (7.6% in 1992 versus 4.9% in 2001). The euro’s share over the last ten years, after adjusting for the statistical effect stemming from the elimination of the legacy currencies, has remained more or less the same.[18]

The euro’s position as a reserve currency among developing countries, however, was slightly stronger (15.3%), compared with the US dollar’s 64% and the yen’s 4.5%. Nevertheless, figures for 2003 could very well show noticeable improvement in the euro’s share as there has been a wealth of anecdotal evidence during the last year of shifts (or planned shifts) in the reserve portfolios of a number of large reserve holders, particularly in Asia.[19]

On the other hand, the euro is used as an anchor currency in more than 50 non-Euro zone countries (mainly in Europe, Eastern Europe, the Mediterranean, the Middle East and Africa – the so-called “Euro time zone”), although collectively such countries account for only approximately 4% of world GDP and 17% of Euro zone GDP.

d) Conclusions
Although the relative shares of the three leading international currencies vary depending on the market segment, in broad terms one can maintain that the dollar accounts for roughly 50% of international currency functions, the euro for approximately 25%-30%, while the yen and other international currencies account for the remaining shares.[20]

If a stable link between the overall global share of international currency functions and the size of the Euro zone economy relative to those of the other international currencies (the US, Japan, the UK and Switzerland) could be maintained, then the major implication would be that the current constellation of market shares among the major currencies could be close to a “steady state” distribution of international currencies roles.[21]

On the other hand, in a number of segments (particularly in trade invoicing, foreign exchange markets and official reserves) the euro could still have much terrain to capture, even without considering the possible expansion of the Euro zone to include the UK, the Nordic countries and others from central and eastern Europe.

Obstacles and Potential Stimuli for Euro Internationalisation

There exists a broad consensus with respect to the necessary structural and policy pre-requisites for any particular currency to begin to take on an increasingly important international role. First, a currency must be widely perceived as sound and stable. Second, the currency’s issuing economy (or “habitat”) must be large relative to world GDP and constitute a significant share of world trade. Third, the issuing economy’s financial markets must be open and relatively well-developed – that is, broad, deep and liquid.[22] Finally, a sufficient level of credible international political power, expressed in terms of the global political engagement of the issuing economy, is likely to also be an important prerequisite for any currency attempting to displace the status quo’s leading currency to become the world’s new key currency.[23]

Even still, any currency emerging as a potentially leading international currency – like the euro – will necessarily face the serious obstacle implicit in the dominant currency’s incumbent position, which is strengthened by the natural inertia historically observed in international currency markets and underpinned by the network externalities that make the market sphere for international currencies highly oligopolistic.[24]

To overcome such inertia and challenge the centrality of the leading international currency, a challenger’s currency must prove sufficiently convincing to a sufficiently large share of market actors with respect to all three pre-requisites and in relation to a broad range of private and public uses. Once a critical mass of users has been achieved, network externalities are increasingly less likely to continue placing a break on the challenger’s increasing market share and — on the contrary — will begin to facilitate it.[25]

Furthermore, increasing market share in the financing and investment segments are likely to interact positively with increasing market share in the foreign exchange markets leading, in turn, to wider use of a currency in trade invoicing and, eventually, to a greater share of the world’s official reserves. While private market agents constitute the essential element in this process, there appears room for official policies – of both the home economy and third country state actors – to interact with private market decisions, thereby stimulating and reinforcing the markets’ embrace of a new international currency.

Officially, the ECB takes a neutral stance on the internationalisation of the euro and neither promotes nor discourages it, leaving the process instead to the invisible hand of the markets.[26] Nor is there is any official EU policy objective with regard to the international use of the euro – although there are moments when EU member states may make statements that appear to contradict the de facto EU position (as in the ASEM 4 Chair’s Statement, see above.)  Nevertheless, a number of the domestic policy objectives of the ECB (price stability) and the Commission (more deeply integrated financial markets), along with a number of broad EU goals (enlargement, enhanced productivity via the Lisbon Agenda, and intensified international trade and investment linkages) directly affect the prospects for further internationalisation of the euro. Likewise, the foreign and international economic policies of third countries (particularly in non-Euro zone Europe, the Americas and Asia, see Section 5 below) could also facilitate further euro internationalisation.

The Euro’s Track Record on the Pre-requisites
To date the euro has gone a long way toward fulfilling both the stability and size criteria and, as further progress is made on the EC’s Financial Services Action Plan, the Euro zone continues to deepen and broaden its financial markets. Nevertheless, there remains ample room from improvement, particular with respect to this latter criterion. In addition, the EU’s international political role – along with its future potential – is also still subject to various conflicting interpretations.

a) The perception of the euro as a sound and stable currency
Generally, a currency will be perceived as sound if it exhibits low and stable inflation rates and has developed a track record of sound monetary and fiscal policy management. In the case of the euro, this translates into a high-level of credibility afforded by the markets to the ECB and the maintenance of sufficient Euro zone fiscal restraint as embodied in the Stability and Growth Pact.

When the Maastricht Treaty was signed in 1991, Euro zone inflation was 4% while the Euro zone’s average budget deficit was 5.5% of GDP. Since the inception of the single currency, inflation has been kept under control even in the face of significant adverse price shocks, including the tripling of oil prices in 1999-2000. Currently, Euro zone inflation is just under 2% and long-term expected inflation is even lower. Meanwhile, the Euro zone average budget deficit — even after having experienced a recession (1992-93) and a significant slowdown (2001-03) in the interim — remains around 2%.[27]

In this sense, the euro has achieved a reputation as a sound and stable currency. This perception has likely been bolstered by the sustained appreciation of the euro in 2002 and 2003. If anything, the markets may have come to perceive the ECB’s execution of monetary policy, and the Commission’s role in fiscal policy co-ordination and enforcement of the Stability and Growth Pact, as excessively hawkish, particularly given the momentary weakness of the European and world economies. Notwithstanding the current debate over the desirability of modifying the Stability Pact, however, the firmness and seriousness with which European Union authorities have thus far managed inflation and deficits have fundamentally altered the perceptions dominant among market actors only a decade ago. Contributing to the consolidation of this new perception has been the recent rapid deterioration of the fiscal policy stance in the US.

A potential threat to this reputation for soundness and stability, however, is implicit in the current controversy surrounding the Stability and Growth Pact. With Germany in recession and both Germany and France in a position where they may actually breach the Pact’s maximum 3% deficit threshold for three consecutive years (2002-04), the dilemma resides in foreseeing the angle from which the markets will ultimately judge the euro’s credibility: from that of fiscal stability or from that of sufficiently dynamic growth. Even with looser monetary policy from the ECB, the credibility question will hinge on whether the balance of market concerns leans toward the perceived mid-term inflationary dangers of growing deficits or toward the potential short-term dangers of deflation. Such questions lie beyond the sphere of this paper, but they should be acknowledged as potential threats to the perceived stability and soundness of the euro, crucial for its continued internationalisation.

b) Sufficient relative size of the currency’s “habitat”
It is widely acknowledged that the Euro zone is one of the largest economies in the world with more than 300 million inhabitants (compared with 270 million in the US and 125 million in Japan). The Euro zone currently accounts for some 16% of world GDP (compared with the US’s 22% and Japan’s less than 5%) and nearly 20% of world exports (against the US’s 15% and Japan’s 9%). If the three Euro opt-out countries of the EU (Sweden, Denmark and the UK) were integrated into the common currency, the Euro zone would have 376 million inhabitants (40% more than the US and nearly three times more than Japan) while its GDP would nearly equal that of the US and be more than double that of Japan. Suffice to say, the Euro zone’s relative size in the world economy will increase even further when accession countries eventually join the EMU.[28]

Some sources identify UK entry into the single currency (due to the size of the UK economy, the importance of its financial markets, and its symbolic significance) as one of the critical variables that will determine how much market share the euro will ultimately be able to capture.[29] Nevertheless, it appears that UK entry, in the best case scenario, remains a number of years off into the future. Given the possible political momentum that is likely to be produced by earlier entry into the euro by the first of the opt-out EU member states, a potentially key event will take place in September 2003 when Sweden holds its referendum on the euro. Currently the No vote retains a substantial lead in opinion polls (approximately 44% to 34% in late July, with 22% still undecided), although a deeper analysis of the characteristics of public opinion reveals that the Yes vote could still win.[30] The result of the Swedish referendum, in any case, is likely to exercise an important political effect upon opinion in Denmark and the UK and a strong psychological effect on the markets.

c) An open and well-developed financial system
This is the key link in the chain of network externalities. Transaction density and volume in European financial markets must lower transactions costs sufficiently to enable the euro to overcome the inertia inherently favouring the dollar in international markets. As Richard Portes and Hélène Rey concluded in their study of the prospects for euro internationalisation: “The key determinant of the extent and speed of internationalisation of the euro will be the transactions costs in foreign exchange and securities markets.”[31]

Investors are interested in prospects for returns and therefore demand high levels of efficiency and liquidity in financial markets. As a result, the Euro zone must create an integrated network of financial markets which are broad, deep and liquid enough to attract investors to use the euro. Otherwise, the euro could easily fail to gain the sufficient critical mass necessary to capture significant market share from the dollar in the broad range of international currency functions, particularly in foreign exchange markets.

The adoption of the single currency and the implementation of the TARGET payment system have obviously helped to integrate Europe’s financial markets. Nevertheless, Euro zone equity markets, in particular, remain by and large national, as they are still structured around national securities depositories and settlements systems and are rooted in national payment infrastructures. They therefore remain smaller and more fragmented than their dollar zone equivalents.

The Euro zone should continue to remove institutional and economic obstacles that raise the cost of cross-border operations. This implies further harmonisation of accounting rules, tax regimes and legal frameworks, along with the construction of the necessary technical infrastructure for easily handling cross-border holdings and settlements. These barriers are identified by the EC’s Financial Services Action Plan which establishes policy priorities and time-frames for legislative and market measures to tackle three strategic objectives: (1) completing a single wholesale market; (2) developing open and secure markets for retail services; (3) ensuring continued stability for EU financial markets. It also identifies tax obstacles and distortions that inhibit the creation of an optimal single financial market.

As of early 2003, 30 of the 42 measures laid out in the Action plan had been completed. Nevertheless, the most significant measures remain. At this stage, therefore, this relative lack of broad, deep and liquid financial markets in Europe continues to undermine the euro’s full potential as an international asset.[32]

In this respect, it is significant that, according to the most recent data, transactions costs — reflected broadly in the bid-ask spreads on the foreign exchange markets — have so far failed to narrow and, indeed, have even shown some signs of increasing since the introduction of the euro. Although the available data shows no indications of structural changes in the spreads between the deutschmark (euro) and the yen or the Swiss franc, during the first two years of the euro’s existence (1999 and 2000), the spreads measured in basis points on USD/EUR trading in EBS (Electronic Booking Services) were consistently 20% to 50% higher than previously observed spreads (from February 1997 to December 1998) in DEM/USD trading. In any event, during the euro’s first two years, an increase in spreads was observed for only one currency pair – the ESD/EUR market, where spreads rose from 0.7-0.9 basis point to around 1.2 basis points – suggesting that euro spreads in general had not risen systematically in comparison to previous deutschmark spreads.[33]

On the one hand, this evidence points to the conclusion that there has been no systematic deterioration in euro liquidity which might have had potentially detrimental impacts on euro internationalisation. Indeed, after peaking in June 2000, the USD/EUR spread proceeded to taper off slightly to 1.2 basis points in February 2002. Furthermore, the ECB has identified evidence which suggests that the observed increase in spreads on USD/EUR trading has been the result of the statistical effect generated by the interaction of the euro changeover, pre-exiting quoting conventions and dollar appreciation.[34]

On the other hand, given that this is largest bilateral foreign exchange market in the world, and considering that the status of the euro and the US dollar on foreign exchange markets remains different, this initial spread increase may be perceived by market actors as being more harmful to the euro than to the US dollar. [35]  Therefore, one could conclude that further deepening and broadening of euro financial markets and increases in euro liquidity would necessarily be required for continued significant progress in euro internationalisation.

d) The European Union’s international political influence
While it remains beyond the scope of this paper, at least a general comment on the relevance of the EU’s political influence would be in order. This is perhaps one of the key issues on which the international weight of the euro would seem to be chronically weak. Although there are conflicting interpretations of the recent development and future potential of the EU as an integrated and influential political power in the international system, it seems clear that given the peculiar nature of the EU, it will be some time before it wields its full potential as an international political force (indeed, if it ever does). This reality could imply an additional break on the internationalisation of the euro which, along with the inherent incumbency advantage currently enjoyed by the dollar, might quickly place limits on the euro’s international role.

On the other hand, should third countries begin to adopt policies which facilitate further euro internationalisation, it is plausible that enough momentum might be generated toward euro use – despite the EU’s current political shortcomings – to overcome the dollar’s incumbency advantage. This critical stimulus to euro internationalisation could in turn provide the EU with the increased macroeconomic flexibility (see Section 4 below) necessary to facilitate a more effective and credible international projection. A more credible and vigorous foreign policy would in turn underpin further euro internationalisation.

Given that the recent Iraq crisis has highlighted the widening rift not just between the US and European economic models but also between their distinct “Hobbesian” and “Kantian” visions of the world, it would seem logical that other countries begin to assess their strategic options when it comes to policies that might exert a relevant if  marginal effect upon the international currency map. Asian countries might consider debating such strategic options within the ASEM context.

It seems clear that a broad range of distinct policy options expressing the “strategic preferences” of third country state actors (see Section 5 below) could facilitate or hinder continued euro internationalisation.[36] Given the strength of the inherent inertia exhibited by the markets, together with the perceived difficulties that confront the prospects of further European financial integration, such third country “strategic preferences” (in non-Euro zone Europe, the Americas and Asia) might even prove to be the key factor – the required systemic shock — determining the ultimate success of the euro’s bid, not just to take on a larger role as an international currency, but to actually challenge the dollar as a new co-hegemonic or even leading international currency.

However, there remain two essential, inter-related domestic European developments that could help the euro attain equal status with the US dollar. First, improved productivity and competitiveness of the euro area could raise the rate of return on euro area assets, boosting the role of the euro as an investment currency. This prospect derives from the profound changes currently underway in Europe in areas such as product and labour market regulations, public debt and fiscal deficits, and social security systems. Further serious progress on the EU’s Lisbon Agenda would provide one of the most effective stimuli to euro internationalisation currently within the realm of influence of EU policymakers. The health care and pension reforms now proposed by the German government represent a promising development in this regard.

Second, continued financial market integration — a necessary pre-condition for further investment in euro assets — will require changes in, and harmonisation of legislation, regulations, market practices and infrastructures.[37] The ultimate fate of the European Commission’s efforts to establish a single, integrated European financial market will be the litmus test in this realm.

Finally, the recently consolidated credibility of the euro is at least partially at stake in the current controversy over the Stability and Growth Pact in the context of looming recession in Europe.

Implications of Further Euro Internationalisation

a) Europe
The implications of further euro internationalisation for Europe are related most directly to the advantages and disadvantages that adhere to an economy issuing a dominant international currency.

The first advantage is that of seigniorage. Non-interest-bearing claims upon the economy issuing the key currency are denominated in its own currency, allowing this economy to obtain real resources (net imports) in exchange for nearly costless notes. Given that most international currency reserves are held in the form of government bonds, there is ultimately some cost to the issuing economy. In net terms, however, this most basic form of international currency seigniorage can produce gains of a magnitude of 0.1% of GDP, according to the consensus estimates of the current flows of international seigniorage to the US.[38]

There is also another indirect source of seigniorage that could begin to accrue to the Euro zone as a result of greater international use of the euro: a liquidity discount.  It has been estimated that the US dollar’s position as the leading international currency reduces the real yields the US government must pay on its debt by between 25 and 50 basis points, yielding an additional annual flow in international currency seigniorage of another 0.1% of GDP. Furthermore, a recent study of the welfare gains for the Euro zone under a scenario in which the euro gains equal status with the dollar suggests additional annual gains of upwards of 0.2% of GDP (while both the US and Japan would stand to lose 0.04% and 0.07% of GDP, respectively).[39]  The total gain for the Euro zone would therefore be in the realm of 0.3%-0.4% of GDP annually. Most of the Euro zone’s welfare gain would come from gains in the financial markets, particularly as a result of lower transactions costs, while the US and Japan would lose as a result of the euro taking over at least some of the dollar’s function as a vehicle currency beyond Europe.

Perhaps even more important than what might be considered relatively insignificant gains in seigniorage and welfare would be the heightened degree of macroeconomic flexibility typically enjoyed by the economy issuing the leading international currency. Such an economy is inherently less vulnerable to changes in the value of its currency than are others. Most US imports are denominated in dollars (for example, petroleum), as are the majority of its exports. Dollar depreciation therefore does not automatically translate into higher import prices in the US. This implies that the US economy is relatively shielded from the inflationary impacts of currency depreciation.

This is particularly true when the currency leader’s economy is relatively closed to trade in statistical terms. For example, international trade accounts for 13%-15% of US GDP (compared with 15% to 20% in the case of the Euro zone economy, although this level of GDP exposure will fall as the non-euro EU countries eventually join the single currency). This implies a greater relative freedom from the necessity of tighter monetary policy in the wake of currency depreciation, allowing the currency leader greater capacity to continue running stimulative macroeconomic policies and growing at a faster rate (free of inflationary pressures) than otherwise would have been the case.

The currency leader also enjoys relative freedom from other currency constraints, such as the necessity to maintain sufficient foreign currency reserves to secure critical imports. The most crucial example is that of petroleum imports which have been priced in the world’s leading currency, the US dollar, ever since the end of the Second World War. Because the dollar has dominated the pricing and payments system of the international petroleum industry, the petrodollar surpluses of oil exporting countries have naturally flowed to the US economy, contributing to the financing of its deficits and underpinning its relative strategic advantages vis a vis allies and adversaries alike.

Exhibiting a near monopoly status in international trade and financial markets, as is the case currently for the US dollar, the currency leader does indeed enjoy a long, soft and stable line of credit from the world’s investors who (lacking other stable and liquid alternatives) provide the currency leader with the capacity to sustain larger internal and external deficits for much longer periods of time than other countries.[40] This can translate into greater political flexibility and geopolitical advantage. In the case of the US, such macroeconomic flexibility has allowed it over the years to run large current account and budget deficits which, in turn, have facilitated the US’s capacity to successfully execute its strategic agenda (during the 1960s, the 1980s and again during the present decade) and to impose more effectively its own imprimatur upon the international system.[41]

To the extent that euro internationalisation continues, and the euro begins to mount a serious challenge to the dollar’s hegemony, the Euro zone is likely to begin to accrue an increasing share of such macroeconomic flexibility at the expense of the US. Such a growing capacity to run larger internal and external deficits, and to finance them at increasingly lower interest rates, will potentially allow the Euro zone economy to both grow faster and budget more resources for a more significant and convincing EU international projection (including more serious and coherent military expenditures).

This capacity to tap into what traditionally have been European and Asian savings financing US deficits – and, by extension, the US’s strategic agenda – could potentially serve to strengthen the EU’s cohesion and influence in the realm of foreign and security policy. The resulting heavier international political influence, in turn, could feedback to provide even greater stimulus for further euro internationalisation. In brief, the successful internationalisation of the euro (in a scenario of shared or full international currency leadership) could help promote the goal of deeper and more authentic multilateralism in the international system if euro internationalisation moves forward hand in hand with greater international political influence, allowing the EU to more effectively promote its vision of a multilateral international political system.[42]

On the other hand, the management of monetary policy can be complicated as the result of the internationalisation of a currency. This was ostensibly the reason why the Bundesbank was opposed to further internationalisation of the deutschmark during the 1970s and 1980s. Nevertheless, the potential instabilities that might be imported via a currency’s international status, along with the resulting disadvantages for the executors of domestic monetary policy, are inversely related to the relative size of the economy in question and the realistic possibilities that such a currency might one day become the leading international currency.  In this sense, the EU is ultimately likely to make a very different cost-benefit analysis of further euro internationalisation – despite its current official position of neutrality – than did the Bundesbank with respect to the deutschmark in the past.

b) Implications for Asia
Euro internationalisation – and its potential to develop further – presents Asian countries with a number of possible benefits, challenges and opportunities for co-operation with Europe, possibly within the ASEM context. First, the euro has helped reinforce macroeconomic stability in Europe, the world’s second largest economic and trading bloc. To the extent that the EU and Asia have become each other’s second largest trading partner, this increasing economic stability is beneficial for Asia.

As the euro becomes increasingly acceptable as an international financing and investment currency, new options for financial diversification open up to Asian economic actors. Asians could potentially provide the missing element to international demand for euro-denominated assets. Further international use of the euro might also strengthen European political cohesion with potentially beneficial effects on the management of the international monetary system. Given Asia’s recent vulnerability to external economic shocks and international contagion, such developments could be seen as positive within Asia.

The unification of European currencies and the euro’s successful internationalisation provide Asian economies with a relevant reference experience in economic, financial and monetary integration. While the internationalisation of the euro does provide potential international competition vis a vis the yen (or any other Asian currency that might possibly exercise an international role in the future), active Asian collaboration to stimulate further international use of the euro might be carried out in a fashion which both helps the cause of the euro and lays the foundation for further intra-Asian collaboration and  integration. The implications for the shape of monetary map in Asia and the world – and, indeed, for the shape of the international political system — could be profound.

Possible Implications for ASEM and Closer Economic Partnership

Given the EU’s relative weaknesses in generating sufficient credibility as a relevant international political force, it is likely that official policy actions by third countries will be particularly important in providing the stimulus needed to provoke private actors into a broader use of the euro. Given that currency internationalisation takes on an increasing momentum once the critical resistance threshold has been passed, Asian countries hold a potentially strategic key to the future of the euro as a co-leading currency – or even as the key international currency overtaking the dollar.

Although Asian countries within ASEM are likely to be keenly aware of their relative monetary and strategic dependence on the US, the ASEM context provides a potentially creative channel for considering new strategic options. While it may not be political propitious to pursue policies which directly promote the international use of the Euro, it may be feasible to engage in collaborative actions in the ASEM context which, while promoting further Asian co-operation and integration, also indirectly stimulate wider international use of the Euro. One such area for European-Asian collaboration would be in the further development of Asian bond markets in which the euro might play at least a secondary role.[43]

In conclusion, it is important to highlight that European and Asian ASEM partners should begin to seriously consider the ASEM process as a useful forum for rethinking the strategic nature of the European-Asian relationship. Given recent international developments, actions within the ASEM context that facilitate further euro internationalisation could be of historic importance.

Paul Isbell
Senior Analyst,International Economy and Trade, Elcano Royal Institute for International and Strategic Studies


ASEM Task Force for Closer Economic Partnership

between Asia and Europe

Asian participants

Dr. Narongchai Akrasanee (Thailand), Chairman of Seranee Holdings Co., Ltd., President of Schiller-Stamford International University, Advisor to the Deputy Prime Minister on Economic Affairs, Former Minister of Commerce.

Mr. Djoko Mulyono, SE, MA, (Indonesia), Advisor of Indonesia-China Business Council, Indonesia Forwarder Association, Indonesia Surveyor Association, and Indonesia Appraisal Association.

Mr. Toyoo Gyohten (Japan), President, Institute for International Monetary Affairs, Senior Advisor, the Bank of Tokyo-Mitsubishi Ltd.

Mr. Hoang Tich Phuc (Vietnam), Senior Advisor to the Minister for Trade, former Assistant Minister of Trade.

Mr. Il SaKong (Korea), Chairman & CEO, Institute for Global Economics.

Prof. Tommy Koh (Singapore), Ambassador-at-Large in the Singapore Ministry of Foreign Affairs, Director of the Institute of Policy Studies, and Chairman of the National Heritage Board.

Mr. Melito S. Salazar, Jr. (the Philippines), Member, Monetary Board, Central Bank of the Philipines.

Tan Sri Dato’ Seri Dr. Mohamed Noordin Sopiee (Malaysia), Chairman, Institute of Strategic and International Studies of Malaysia.

Prof. Zhang Yunling (China), Professor of International Economics, Director of Institute of Asia-Pacific Studies and Director of Research Center of Regional Cooperation at the Chinese Academy of Social Science.

Dr. Haji Ismail Haji Duraman (Brunei)

European participants

Daniel Bernard (F) Chairman of the Board and Chief Executive Officer, Carrefour Group.

Magnus Blomström (SWE) President of the European Institute of Japanese Studies and Professor of Economics, Stockholm School of Economics.

Leon Brittan (UK) Vice-Chairman of UBS Warburg, Member of the House of Lords. Previously: Vice President of the European Commission with responsibilities for Competition Policy, Financial Institutions, Trade Policy and relations with North America, Australia, China, Hong Kong, Japan and Korea, UK Secretary of State for Trade and Industry.

Henning Christophersen (DK) previously European Commissioner for Economic and Financial Affairs.

Gianni De Michelis (I) previously Deputy Prime Minister, Minister of Foreign Affairs and Minister of Labour, Italy.

Alfredo Pastor (ESP) Dean and Vice President China International Business School, Professor of Economics IESA, Spain. Member of the Board of various major Spanish multinational enterprises. Previously Secretary of State for Economic Affairs, Spain and Board Member, Bank of Spain.

Dr. Gert Vogt (Germany) Chairman, ASEM-Initiative of German Business.

[1] ASEM 4 Chair’s Statement, p. 3.  ‘Leaders agreed to work towards a closer ASEM economic partnership. To this end, they tasked ASEM Coordinators to set up an action-oriented Taskforce. Taking into account work already carried out within the ASEM economic pillar, this Taskforce should consider three areas: Trade, Investment and Finance. These areas could include issues such as the creation of a Eurobond market in Asia and the use of the Euro as an international currency. The Taskforce should consist of five experts from each of the two regions. Leaders requested that an interim report be prepared for submission to Foreign, Economic and Finance Ministers in 2003, with a view to submitting a final report to ASEM 5.’
[2] See ASEM Task Force, Interim Report for the ASEM Foreign, Finance and Economic Ministers’ Meetings, July 2003, p. 2.
[3] The most recent data on euro internationalisation comes from the European Central Bank (as of the summer of 2002) and the International Monetary Fund (as of the end of 2001). Data on the status of euro internationalisation in the summer of 2003 will not be available until the end of the year.

[4] The most recent data from the IMF for the currency distribution of official reserves only captures levels from the end of 2001. However, anecdotal evidence from 2002 suggested that the Northeast Asian (China, Taiwan, Hong Kong, South Korea) central banks had begun (or were considering) converting dollar reserves into euros, while evidence from 2003 suggested that other Southeast Asian central banks (like Indonesia and Singapore) were considering such a move.  See footnote 17.

[5] Otmar Issing, Executive Board, ECB, “The Euro – A Stable International Currency,” February 27, 2003, Address to the Budapest Academy of Sciences.

[6] European Central Bank, Review of the International Role of the Euro, December 2002.

[7] The “narrow” measure of international debt securities isolates only those issues in a currency other than the currency of the country in which the borrower resides, underlining the international financing role of a currency in a strict sense. The “broad” measure also includes issues denominated in the home currency of the borrower, so long as the issue is targeted at the international financial market.

[8] European Central Bank, Review of the International Role of the Euro, December 2002.

[9] Ibid.

[10] Ibid., and European Central Bank, Review of the International Role of the Euro, 2001.

[11] European Central Bank, Review of the International Role of the Euro, December 2002.

[12] Ibid.

[13] Benjamín J. Cohen,  “Life at the Top: International Currencies in the 21st Century,” in Essays in International Economics (Princeton, NJ: International Economics Section, 2000).[14] Bank of International Settlements, Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity 2001, March 2002; and European Central Bank, Review of the International Role of the Euro, December 2002.

[15] European Central Bank, Review of the International Role of the Euro, December 2002.

[16] Javad Yarjani, “The Choice of Currency for the Denomination of the Oil Bill,” Head of OPEC’s Petroleum Market Analysis Department in an address to the Spanish Presidency of the EU, April 14, 2002. (

[17] Tony Sitathan, “Euro could outshine dollar in Indonesia,” Asia Times,, April 2003.

[18] International Monetary Fund, Annual Report, 2002.

[19] See, for example, John Garnaut, “US Dollar Losing Its Position As Asia’s Reserve Currency,” July 17, 2002,; and Tony Sitathan, “Euro could outshine dollar in Indonesia,” Asia Times,, April 2003.

[20] European Central Bank, Review of the International Role of the Euro, December 2002, p. 53.

[21] Ibid.

[22] See, for example, Nicholas C. Garganas, “The International Role of the Euro,” BIS Review 6/2003;  Otmar Issing, Executive Board, ECB, “The Euro – A Stable International Currency,” February 27, 2003, Address to the Budapest Academy of Sciences; and Benjamín J. Cohen,  “Life at the Top: International Currencies in the 21st Century,” in Essays in International Economics (Princeton, NJ: International Economics Section, 2000).

[23] C. Fred Bergsten, Dilemmas of the Dollar: The Economics and Politics of United States International Monetary Policy, second edition (Armonk, NY: M.E. Sharpe, 1996) pp. 122-123.

[24] Paul R. Krugman, “The International Role of the Dollar,” in Paul R. Krugman, Currencies and Crises, 1992 (Cambridge, MA: MIT Press), ch. 10; Kevin Dowd and David Greenaway, “Currency Competition, Network Externalities and Switching Costs: Towards and Alternative View of Optimum Currency Areas,” Economic Journal 103 (September 1993), 1180-1189.

[25] Richard Portes and Hélène Rey, “The Emergence of the Euro as an International Currency,” in David Begg, Jürgen von Hagen, Charles Wyplosz, and Klaus F. Zimmermann, eds., EMU: Prospects and Challenges for the Euro, 1998 (Oxford: Blackwell), 307-343.

[26] European Central Bank, “The International Role of the Euro,” ECB Monthly Bulletin, August 1999, 31-53; and European Central Bank, Review of the International Role of the Euro, December 2002, p. 55.

[27] Otmar Issing, Executive Board, ECB, “The Euro – A Stable International Currency,” February 27, 2003, Address to the Budapest Academy of Sciences; and Klaus Regling, “The Euro: Achievements and Challenges,” in The Arrival of the Euro Currency: January 2002 and Beyond, Institute for International Monetary Affairs (Tokyo), Occasional Paper 11, January 2002.

[28] Nicholas C. Garganas, “The International Role of the Euro,” BIS Review 6/2003.

[29] See, for example, Richard Portes and Hélène Rey, “The Emergence of the Euro as an International Currency,” in David Begg, Jürgen von Hagen, Charles Wyplosz, and Klaus F. Zimmermann, eds., EMU: Prospects and Challenges for the Euro, 1998 (Oxford: Blackwell), 307-343; and Javad Yarjani, “The Choice of Currency for the Denomination of the Oil Bill,” Head of OPEC’s Petroleum Market Analysis Department in an address to the Spanish Presidency of the EU, April 14, 2002 (

[30] “Demoskop: Nejsidans stora övertag an chimär,” Dagens Nyheters (Internet version:, July 31, 2003.

[31] Richard Portes and Hélène Rey, “The Emergence of the Euro as an International Currency,” in David Begg, Jürgen von Hagen, Charles Wyplosz, and Klaus F. Zimmermann, eds., EMU: Prospects and Challenges for the Euro, 1998 (Oxford: Blackwell), 307-343.

[32] Nicholas C. Garganas, “The International Role of the Euro,” BIS Review 6/2003.

[33] European Central Bank, Review of the International Role of the Euro, December 2002, p. 34.

[34] See the ECB’s explanation of the so-called “pip” or “granularity” hypothesis put forward by Goodhard  et al. in “Analysis of spreads in the dollar/euro and Deutsche Mark/dollar foreign exchange markets,” Economic Policy, Issue 25, October 2002, pp. 535-552; and European Central Bank, Review of the International Role of the Euro, December 2002, pp. 29, 33-34, 36.

[35] European Central Bank, Review of the International Role of the Euro, December 2002, pp. 34, 36.

[36] Benjamín J. Cohen,  “Life at the Top: International Currencies in the 21st Century,” in Essays in International Economics (Princeton, NJ: International Economics Section, 2000).

[37] Nicholas C. Garganas, “The International Role of the Euro,” BIS Review 6/2003.

[38] G.S. Alogoskoufis and Richard Portes, “International Costs and Benefits of EMU,” in The Economics of EMU, European Economy, 1991, Special Edition no. 1, pp.231-45; European Commission, External Aspects of Economic and Monetary Union, Directorate General II, 1997; J. Frankel, “Still the Lingua Franca: The Exaggerated Death of the Dollar,” Foreign Affairs, 74:4, pp. 9-16; Kenneth Rogoff, “Foreign and Underground Demand for Euro Notes,” paper for Economic Policy Panel, October 1997.

[39] Richard Portes and Hélène Rey, “The Emergence of the Euro as an International Currency,” in David Begg, Jürgen von Hagen, Charles Wyplosz, and Klaus F. Zimmermann, eds., EMU: Prospects and Challenges for the Euro, 1998 (Oxford: Blackwell), 307-343.

[40] Benjamín J. Cohen,  “Life at the Top: International Currencies in the 21st Century,” in Essays in International Economics (Princeton, NJ: International Economics Section, 2000).

[41] Paul Isbell, “The Shifting Geopolitics of the Euro,” Análisis del Real Instituto, September 23, 2002 (

[42] See Paul Isbell, “La economía política de la dolarización,” POLÍTICA EXTERIOR, September/October 2000, and “The Dollar and the Euro: The Smoke and Mirrors of Currency Politics,” in REDEN: The Spanish Journal of North American Studies,, University of Alcalá de Henares. No. 15, Fall 2000.

[43] See Institute for International Monetary Affairs, “Issue Paper on Creating Asian Bond Markets,” prepared for the ASEM Task Force Meeting in Tokio, September 2003.

Written by Paul Isbell

Paul Isbell was Senior Research Fellow at the Elcano Royal Institute, and former Senior Analyst for International Econimics. He is also the CAF Energy Fellow at the Center for Transatlantic Relations (CTR) at Johns Hopkins University’s School for Advanced International Studies (SAIS), in Washington, D.C., and the lead energy specialist of CTR’s flagship projects, the […]