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iasparliament
February 08, 2019
6 months
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What is the issue?

  • It was claimed that the euro would rival the US dollar as a second global reserve currency.
  • But the hopes have failed to materialise, and euro’s importance is about the same as it was two decades ago.

What is the recent move?

  • The European Commission recently published a Communication entitled "Towards a stronger international role of the euro".
  • The European Commission considers that the eurozone would benefit if the euro played a more global role.

How has the Euro's importance been?

  • There is widespread use of euro banknotes outside the single-currency area.
  • [Bank notes are similar to bonds; promissory note issued by a bank in large denominations, which is interest bearing and payable on demand.]
  • On this measure at least, the euro has been a big success.
  • Bank note issuance was a profitable business for central banks, because they could invest the proceeds in government bonds with a decent yield.
  • With interest rates at 5%, and Euro 1.2 trillion of notes in circulation, the European Central Bank (ECB) could have generated revenue of about Euro 60 billion a year.
  • Currency in circulation has more than doubled over the last 20 years, both in absolute terms and as a percentage of eurozone GDP.
  • Furthermore, it is commonly estimated that a large fraction of euro cash is used outside the eurozone.

Why is the Euro dream unfeasible?

  • Bank notes - The economics of banknote issuance have changed now, and at today’s negative interest rates, currency issuance is no longer profitable.
  • This might be another reason why the ECB decided to stop issuing the Euro 500 note.
  • Borrowing - Another argument for having a global reserve currency is that foreign borrowing becomes cheaper.
  • It is a privilege the United States enjoyed owing to the dollar’s status as the world’s main reserve currency.
  • But while issuing dollar-denominated debt is an important advantage for the US (the world’s largest debtor), the eurozone is a net creditor.
  • Also, with real interest rates tending to be higher in dollar terms, it would be better for the eurozone’s external assets to be denominated in dollars than in euro.
  • Power - The extra-territorial application of sanctions by the US makes it extremely difficult for European companies to maintain trade ties with Iran.
  • This is because most of Iran’s international trade is invoiced and settled in dollars.
  • In this context, it is in Europe’s interest for the euro to play a larger global role.
  • However, the ability of the US to apply sanctions so widely is essentially due to its diplomatic and military power.
  • So even if the euro played a much larger role in global finance, the US would remain dominant in terms of hard power.

What could be done?

  • The eurozone currently is facing enough economic challenges without the additional burden of issuing a global reserve currency.
  • So the euro could better increase its global role only by slowing the relative decline of the eurozone economy through rapid growth.

 

Source: Business Standard

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