The euro as a global trade currency

Abstract

The creation of the European Union's (EU's) Economic and Monetary Union (EMU) and its euro is one of the most important international monetary developments of the post-Bretton Woods era as it will cause an unprecedented change in the world's monetary and trade structure since the collapse of the fixed exchange rate system. The implications are far from clear. A change of such a magnitude will have profound effects not only on the world's trading system but also on foreign exchange and the distribution of central bank reserves. It is the objective of this paper to provide an analysis of the potential of the euro as a global trade currency alongside the U.S. dollar and its subsequent impact on the distribution of central bank reserves and on the foreign exchange markets. How the European EMU and its euro will affect the rest of the world depends largely on two related questions. First, will the euro challenge the U.S. dollar as the world's main trade, reserve, and investment currency? Second, will the European EMU project make the global monetary system more or less stable? The answer to these questions will depend on the membership of the EMU, on the European Central Bank's ability to ensure price stability in the presence of asymmetric shocks, on the EMU governments’ ability to maintain socially acceptable levels of employment, and on EMU's credibility as perceived by financial markets. Although the euro will immediately assume an international role, it is unrealistic to expect it quickly to supersede the U.S. dollar in global trade and financial transactions. It does, however, have the potential easily to surpass the current trade and investment role of the deutsche mark if it remains stable and if a number of potential problems are resolved by the EU in general and the future EMU member nations in particular.