Euro now world’s second most important currency after dollar

Since its introduction, the euro has been gaining increasing international importance. Although the US dollar continues to play the main role in the international financial and monetary system, the euro is now firmly established as the world’s second most important currency. Even so, the euro is still a long way from gaining equal status with or from replacing the dollar as the world’s leading currency. As shifts in the international monetary system take time to develop, the present ranking will not change in the foreseeable future. International investor confidence in the stability policy of the Eurosystem is the main reason for the success of the euro on the international stage.

One measure of the importance of a currency is its use as an international reserve and anchor currency. Since its launch, the euro has become increasingly popular as a reserve currency. In 1999, 18% of all foreign exchange reserves recorded worldwide were denominated in euro. This was equivalent to the total reserves of the national currencies, or legacy currencies, which the euro replaced. By contrast, in mid-2008 (more recent data are not yet available) 27% of reserve assets were denominated in euro (chart 1). This increase is due largely to the appreciation of the euro; at the end of June the euro was worth almost 48% more than its average value in 1999. During the same period the US dollar’s share as a reserve currency fell from over 70% to just under 64%. However, this means that the dollar still has a clear lead over the euro; furthermore, the dollar has since appreciated again considerably. After adjustment for exchange rate movements, shifts between the currencies have slowed down significantly but, even allowing for this fact, the euro has gained ground.

The euro has likewise become more important as an anchor currency. About 50 countries, including many very tiny states, now use the euro as an anchor and reference currency; they peg the exchange rate of their own currency to the euro. In some countries, Russia, for example, the euro is also a component of a basket of currencies to which the domestic currency is linked.

However, major indicators also include those that are more strongly influenced by private economic players. The use of the euro as an investment or transaction currency is of interest, for example.

It is true that the US dollar still predominates in foreign exchange dealings; after all, more than 86% of all foreign exchange transactions are still settled in dollars (chart 2). While the share of the dollar, or that of the yen (16.5%), has declined slightly in favour of the currencies of emerging market economies and other industrial countries in the past few years, the euro’s share has been more or less stable at 37% (the percentages of currencies involved in foreign exchange dealings add up to 200% as each transaction involves two currencies).

The euro is growing in importance as a transaction and settlement currency. The percentage of invoices made out in euro in the euro area to customers outside the euro area is rising. This percentage is highest in Germany, incidentally. Just over two-thirds of German exports to non-euro-area countries are now invoiced in euro. However, countries outside the euro area are also settling an ever increasing amount of real economic business in euro. This is especially true of EU countries in central and eastern Europe which have not yet introduced the euro.

Meanwhile, the euro has likewise become more important as the currency of choice for international bonds: in 2007 it had a share of just over 32% of international debt securities outstanding (bonds and money market paper which, from the borrower’s perspective, had been issued in foreign currency). This was approximately 10 percentage points more than in 1999, a development which was at the expense of the US dollar (43%) and the Japanese yen (5%) alike.

Generally speaking, regional concentration has a very strong influence on the international position of the euro. The single currency is especially important in countries which are geographically close to the euro area or which have an institutional affinity with it. For example, the euro plays a much more significant role in London than in New York or Hong Kong. In the case of EU countries in central and eastern Europe, their expected accession, sooner or later, to the Eurosystem is a major incentive to use the euro.

The use of euro banknotes and coins is also marked by a regional concentration of this kind, for example, in the states of the former Yugoslavia. Euro banknotes are widely used as a means of payment although their main use is for storing value.   In many countries the circulation of euro banknotes is linked to traditions dating from the D-Mark era. It is not possible to establish the exact percentage of euro banknotes and coins in circulation outside the euro area; it is estimated to be almost one-fifth.

The increasing international importance of the euro is not the result of a deliberate attempt to promote it. The Eurosystem does not take steps either to foster or to hinder the international importance of the euro; it adopts a neutral stance. The disadvantages which can arise from playing a key currency role are not so onerous in the case of the euro area with its comparatively deep and liquid capital market. However, there are also attendant risks to the income in the form of profit from the creation of money (“seigniorage”), which results from the fact that non-interest-bearing or low interest-bearing assets are held in euro in non-euro-area countries. Especially a key currency country with a relatively small capital market will possibly be more vulnerable to swings in investor sentiment, which may then be detrimental to the domestic real economy. This was why the Bundesbank, for example, did not actively encourage the internationalisation of the D-Mark.

For good reason, the Eurosystem sees the growing international importance of the euro as the outcome of a market-induced process. The use of a currency as an international reserve currency, means of payment, investment currency and unit of account ultimately depends on various factors such as the size of the currency area, international integration, the depth of the financial market and the quality of stability policy. The euro area has grown in the past ten years and will soon consist of 16 countries with 325 million inhabitants. The integration of the financial markets has made headway, and the Governing Council of the ECB has consistently pursued its stability-oriented course. Confidence in the stability of a currency is a fundamental requisite for that currency’s international acceptability. That is the lesson we learned from the D-Mark and the lesson we are now learning with the euro. The greater international importance of the euro is therefore also proof of the generally positive stability record of the single currency in the first ten years of monetary union.

There is currently no sign of a general turning away from the dollar in favour of the euro. A change in the international importance of a currency is traditionally a slow process. For example, the dollar did not replace the pound sterling as the leading currency until 1945 even though the economic output of the United States had been surpassing that of the United Kingdom since as far back as 1872. In export performance and with respect to its position as the world’s largest creditor nation, the United States had also long since overtaken the United Kingdom. Only gradual changes in the international use of the two currencies in the medium term can therefore be expected even today.