Distinguished Speaker Seminar: Jean Pisani-Ferry - Why the Euro is NOT the Next Global Currency?

Jean Pisani-Ferry, Director of Bruegel, a Brussels-based think tank, and professor of economics at the Université Paris-Dauphine, gave a lecture entitled "Why the euro is not the next global currency" on 10 December 2009 in Tokyo.

Mr. Pisani-Ferry first revisited the international monetary discussion, followed by a status report on the euro as an international currency, and finally, he analyzed the implications and policy conclusions regarding the internationalization of the euro.

The Triffin Dilemma figured largely in the international monetary discussion and is a key issue in the next phase of the current economic and financial crisis. This dilemma confronts countries whose national currency is also the international reserve currency, just like the United States (US). The US must be willing to run trade deficits to meet the global demands for US dollars, but increasing global demand for US dollars leads to current account deficit that would eventually undermine the stability of the US dollar and its role as a reserve currency.

Given the inherent problems of a one-currency system, is there a way out? What are the prospects of a multi-currency system or of supranational currency? Kindleberger's works on the Great depression may shed light on this issue. In effect, Kindleberger found out that hegemony is conducive to systemic stability, as a hegemon would be able to internalize the externalities of a global public good, including those of an international currency. Whether Kindleberger's analysis holds for a situation in which there are several great economic powers is very much in question today.

In effect, to perform the roles of a hegemon, economic size matters. The size of the US economy has a natural effect to render its currency international. The dominant role of the US was also evident during the last financial and economic crisis with the US Federal Reserve extending currency swap arrangements with major central banks throughout the world. However, this economic domination is very much contested, when the IMF and Goldman Sachs project that the People's Republic of China would overtake the US as the world's biggest economy around 2017. If this would indeed be the case, the continued dominance of the US dollar would be a discrepancy.

Mr. Pisani-Ferry then looked into three possible alternatives toward a more stable currency system: (i) strengthening multilateral surveillance within the current context; (ii) a multi-currency system; and (iii) a supranational currency. He explained that the weakness of the first scenario lay in the absence of a global anchoring provided by one global central bank. What would make the second option viable would be competition among currencies to maintain or expand their respective market share that can act as a disciplining force. In a way, the current system is naturally evolving into a multi-currency system which started at the 2009 G20 Pittsburgh Summit. As for the third alternative, the IMF Special Drawing Rights are a possible supranational currency, but this remains a remote possibility as most big economies are unwilling to enter into this kind of commitment.

The second part of Mr. Pisani-Ferry's lecture examined the euro's first decade. Based on a book which he co-edited with Adam S. Posen that looked into various indicators, he demonstrated that although the euro is a strong currency in the European region and its neighborhood, it is not becoming a rival to the US dollar as the euro's global share had stabilized by mid-2000s.

Recent evidence based on the data from the Bank for International Settlements (BIS) revealed that the US dollar remains the center of foreign exchange transactions and that direct transactions between other major currencies are still limited. Data from the European Central Bank (ECB) and BIS showed that 45% of international debt securities are issued in US dollars. Although the euro came a close second at 30%, its share is not trending upward. In terms of cross border loans, the share of the euro has stabilized at 20%, while the US dollar share is over 50%. Based on what can be gleaned from the available data, it was estimated that about two-thirds of countries' reserves were denominated in US dollar and the euro's share has stabilized at roughly a third. Moreover, many countries that were not in the natural US dollar habitat pegged their currencies to the US dollar. Even Asian countries that traded more with the wider euro region still invoiced their trade mostly in US dollars. The data demonstrated that the euro dominated only in the European region whereas the US dollar dominated trade outside the euro area.

Finally, he identified the factors that limit the internalization of the euro and posited remedies for each. Enlargement of the euro area may add to the economic base but this would have marginal effect as most sizable countries in the region are already European Union (EU) members. Future monetary policy shifts by the US Federal Reserve and the ECB in response to the current crisis may also change the demand of international investors for the US dollar or for the euro. In terms of domestic weaknesses, to mitigate the effects of the crisis, the EU should strengthen pro-growth policies and loosen immigration policies to mitigate demographic decline. To remedy financial fragmentation, several proposals were put forward. The EU should create a market for government bonds to benefit from the liquidity provided by a big bond market. Talks on the creation of a joint bond market were seen as positive developments. As the crisis revealed weak cross border supervision of the euro area, Mr Pisani-Ferry advocated the integration of financial intermediaries and of financial supervision. Governance should also be strengthened to increase policy coordination and improve the quality of surveillance in the EU. Noneconomic factors, such as forging a common foreign policy, may help towards the internationalization of the euro. Finally, the euro area should adopt a proactive stance towards "euroization" and should send out clear signals of assistance to partner countries in times of economic distress.