Key Currency Competition
| Author | Carla Norrlof |
| DOI | 10.1177/0010836709345810 |
| Date | 01 December 2009 |
| Published date | 01 December 2009 |
| Subject Matter | Articles |
Key Currency Competition
The Euro versus the Dollar
CARLA NORRLOF
ABSTRACT
In this article, I investigate whether the euro is set to eclipse the dollar as
the world currency. Although the euro has gained in importance at the
expense of the dollar in all key currency functions, I argue that it is not
about to replace the dollar as the unique currency of global importance.
Notwithstanding America’s current weakness, I argue that different
preferences for monetary and fiscal policy inside the euro-zone, and
the need to coordinate these, will make it difficult to accommodate and
correct large-scale imports over the long term. I also find that taking
on the role of the world’s preferred import destination is bound to
exacerbate internal differences and complicate decision-making.
Keywords: financial crisis; fiscal policy; invoicing; monetary policy; oil;
political economy; price stability; trade; trade deficit
Introduction
One dimension of American hegemony is its role as provider of the key
currency in the international economic system. Following Cohen (2007),
I argue that the dollar has remained the key currency in the international
system and that the euro is unlikely to replace it. I modify Cohen’s position
slightly by drawing attention to the way in which the dollar’s role as unit
of account, and especially store of value, has diminished to some extent.
In addition, whereas Cohen says in passing that we can focus exclusively
on private actors, I think it is worth making public actors’ incentives to
prop up the dollar explicit. These are modest, but non-trivial, additions that
should be of interest for two reasons. On the one hand, the euro seems to
have made more headway in challenging the dollar than Cohen’s empirical
assessment suggests. On the other hand, an evaluation of the incentives
facing official actors reinforces Cohen’s analysis of private actors’ incentives
to stick with the dollar. My main contribution, however, is to claim that the
euro is unlikely to replace the dollar as key currency in the foreseeable
future. As I will demonstrate, the area of trade, where the euro-zone now
excels over the United States, is where the challenge for key currency status
Cooperation and Conflict: Journal of the Nordic International Studies Association
Vol. 44(4): 420–442. © NISA 2009 www.nisanet.org
SAGE Publications, Los Angeles, London, New Delhi, Singapore, and Washington DC
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0010-8367. DOI: 10.1177/0010836709345810
NORRLOF: KEY CURRENCY COMPETITION 421
will be the most difficult. First, I argue that the composition of the euro-
zone’s trade is not conducive to its adoption as unit of account. Second,
I highlight the political difficulties euro-zone countries will encounter in
effectively accommodating trade deficits, a task that has become closely
associated with key currency status. A tentative conclusion, in view of this
latter point, is that strict adherence to price stability may not be necessary,
or even desirable, for key currency status.
In the first section of the article, I briefly outline the benefits and costs
associated with key currency status. The second section is an empirical
assessment of the relative use of the dollar and the euro across key currency
functions. In the third section, I examine the prospects of the euro overtaking
the dollar as key currency country given the various roles it will need to
play. The special focus in that section is the euro-zone’s ability to absorb
large and persistently high shares of world imports, as the United States has
done in the past quarter century. In order to significantly outperform the
United States on this score, the euro-zone would either have to cope with
external price instability, along with the associated risk to internal price
stability, or expand by adding new members to the euro-zone. Both these
scenarios have serious shortcomings.
Net Benefits with Key Currency Status
The euro-zone now comprises 16 countries, i.e. the original Baffling group
(Belgium, Austria, France, Finland, Luxembourg, Ireland, The Netherlands
and Germany) with Italy, Portugal and Spain joined by Greece in 2001,
Slovenia in 2007, Cyprus and Malta in 2008 and Slovakia in 2009. Providing
a common currency with the potential to replace the dollar as key currency
is where Europeans have come furthest in challenging the United States’
hegemonic position and where it will hurt the most (for the United States)
if they succeed.
What are the advantages and disadvantages of providing the key
currency? Whether the benefits from key currency status outweighed
costs was hotly debated in the 1970s (Bergsten, 1975; Cohen, 1977). Today,
new evidence from economics suggests that the gains are substantial and
greater than the costs (Tille, 2003; Gourinchas and Rey, 2005; Lane and
Milesi-Ferretti, 2006). There are two main interrelated costs associated
with key currency status. First, the provider of the key currency has a
responsibility to maintain internal, and to some degree external, price
stability. Second, and related, having key currency status entails higher
opportunity costs in using fiscal or monetary policy (as opposed to
exchange rate policy) as a tool of adjustment (Bergsten, 1975). There
are several benefits from having key currency status: seignorage, positive
valuation adjustments, a positive return differential, policy autonomy,
prestige and leverage (Cohen, 1977; Tille, 2003; Gourinchas and Rey,
2005; Lane and Milesi-Ferretti, 2006; Norrlof, 2010). Seignorage is the
ability to borrow without interest as a result of actors holding one’s
currency in cash balances. International use of the currency implies much
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