Foreign Exchange Vehicles Before and After EMU: From Dollar/Mark to Dollar/Euro?

Abstract

The present paper analyzes the phenomenon of media of exchange in the foreign exchange (forex) market in general and then looks at the potential of the euro, as the future single currency of the European Union, to become such a foreign exchange vehicle in particular. The forex vehicle function is one dimension of an international medium of exchange. As first described clearly by Swoboda (1969), in a world with N national moneys only a small number of the N(N-1)/2 potential bilateral currency markets is actually open and most of the “cross-currency” transactions is performed through a medium of exchange, the forex vehicle. For example, at the present time the exchange of Canadian dollar (CAD) against Swiss franc (CHF) is most often broken down into two transactions — each one involving the US dollar (USD) — CAD/USD and USD/CHF.2 However, a forex vehicle does not have to be unique (Hartmann, 1994). In today’s forex markets a Danish kroner (DKK)/French franc (FRF) transaction usually goes through the Deutsche mark (DEM) — DKR/DEM and DEM/FRF — and not through the USD (Danmarks Nationalbank, 1992). It is important to notice that the roles of the dollar and the mark in these examples are a question of the internal organisation (exchange structure) of the forex market, which differs from the original payments structure in international trade and investment (Krugman, 1980).