By Mathis Richtmann

Steffen Murau (@steffenmurau) is political economist and researcher at Global Development Policy Center at Boston University.

Part 1 of the interview is available here

Are currencies competing with each other? Is the Euro a competitor of the US-Dollar? Let’s remember: the former EU Commission President Jean-Claude Juncker explicitly called for an internationalization of the Euro.

There is certainly a lot of talk about competition. It often seems to be a question of what is your “team”: Team Europe supports the Euro, Team USA supports the US-Dollar. In this kind of competition, the exchange rate tends to be in focus, with each team celebrating the moments when its own currency is stronger than that of the other team. However, understanding currency competition in this way is not particularly helpful. The appreciation or depreciation of a currency is not good or bad per se for one side: exchange rate developments produce winners and losers on both sides.

A more meaningful understanding of currency competition is the extent to which one’s own currency—or more exactly: one’s unit of account—is used for offshore money creation. In quantitative terms, the US-Dollar is far ahead of all currencies in this regard. The Euro is a long way behind, on the second place. All other units of account are miles away with regard to offshore usage.

Now, the central question is: why should it be desirable to have an internationalized currency? In principle, this is a double-edged sword. For example, it entails risks for financial stability because private offshore money creation is difficult to control in the current system. In the event of crises in the Offshore US-Dollar System, investors will try to exchange their offshore US-Dollars into onshore US-Dollars, since the latter are covered by deposit insurance. This may lead to a global bank run on offshore US-Dollars. That is precisely what happened in 2008. In order to prevent this, the Fed has to continue acting as an international central bank, as it is doing right now, even though legally speaking this is not within its mandate.

What are the benefits? I want to emphasize two points. First, the international role of the US-Dollar is lucrative for US banks. They hold a central position in the global financial system as intermediaries between the Fed and the rest of the world. This allows them to concentrate profits in the US. Second, the US government obtains certain geostrategic advantages. While international institutions can autonomously create instruments denominated in US-Dollars outside the US, international payments with these instruments have a legal and technical onshore component. This allows US courts to derive legal jurisdiction for themselves, which they can use to go after companies and activities taking place outside the US. The case of FIFA is representative of this. Equally, the reliance of the Offshore US-Dollar System on onshore legal and technical payment systems allows the US Treasury to impose financial sanctions and cut off unwelcome states from global payment transactions. The Iran sanctions are one such example.

In your view, what would an internationalization of the Euro mean specifically?

The exact meaning of “internationalization” is not very straightforward. Traditionally, there is the idea that it would have to involve the use of the Euro as a means of payment abroad, which could then be connected with the export of Euro-denominated banknotes and their use as a foreign exchange reserve. In addition, you may also look at how strongly the exchange rate or interest rate movements of the Euro influence other currencies.[1]

If we buy into the conceptual framework of the Offshore US-Dollar System, however, Euro internationalization would primarily mean that more financial institutions outside the Eurozone would use the Euro as the unit of account for their financial instruments. On one hand, this can happen because payment transactions are settled in Euros— those financial transactions that mirror the trade in goods and services. The Euro is used in production and supply chains by suppliers from EU countries that are not members of the Eurozone, for example. If these companies need trade credit from their banks, these banks will create offshore Euros accordingly. On the other hand, the Euro can be used outside the Eurozone in financial transactions that are not matched by goods or services transactions. This is the case, for instance, when companies or states outside the Eurozone issue bonds in Euros.

The data of the Bank for International Settlements show that the Euro has primarily a regional significance. At the global level, the US-Dollar takes on this role. Since most actors within the globally integrated financial system have agreed on the US-Dollar as their “key currency”, it makes little sense for individual actors to switch to an alternative currency, or rather an alternative unit of account. If the global oil trade were to switch from US-Dollars to Euros, this would be a huge step for Euro internationalization. But it is highly unlikely that this ever happens. There are strong network effects and path dependencies. Politically, it is not particularly desirable for the US either and may be met with a significant reluctance from their side.

Coming back to Jean-Claude Juncker’s proposal, which actors could drive the internationalization of the euro?

As a political economist, I see various possible mechanisms at play. First, a further internationalization of the Euro could be driven by private sector initiative. If more industries from the Eurozone extend their production and supply chains to countries outside the Eurozone, this will likely entail increased creation of Euro-denominated instruments offshore because the suppliers need Euros for trade finance.

Second, countries that are not members of the Eurozone could push for a stronger role of the Euro in their financial system, thereby contributing to its internationalization. One example is Russia. In the 1990s, it became integrated into the Offshore US-Dollar System by shock doctrine after the collapse of the Soviet Union. In recent years, attempts have been made to “de-dollarize” the Russian financial system, motivated in particular by the problems caused by the US financial sanctions since the crisis in Ukraine. However, this task is not an easy one. While the country has made some efforts to increase bonds denominated in Euros rather than US-Dollars, this has not led to a significant change of the overall picture. Much depends on who wants to invest in such bonds, and in any event Russia still relies on US-Dollars for international commodity trading.

Third, currency internationalization could be part of foreign policy. For example, after the Second World War, the US advanced the internationalization of the US-Dollar through the Marshall Plan. China has been trying for several years to internationalize the Renminbi, recently via the Belt and Road Initiative. Both cases involve strategic long-term foreign investments, made in domestic currency. The EU could try to do the same with the Euro. We could imagine something like an EU geostrategic concept coordinating various policy areas. But—for now—we are far away from such a coordinated strategy. The EU has long had difficulties agreeing on a common foreign and security policy that deserves the name. This is unlikely to change overnight. Within the EU, the interests of members versus non-members of the Eurozone diverge considerably: non-Eurozone member have grown rather skeptical about the advantages of monetary union. Within the Eurozone, the conflict between surplus and deficit countries is far from resolved. Covid-19 has once again put the dispute over Eurobonds on the agenda, which has been a major conflict line for a long time, even though we may now see a certain momentum towards developing the fiscal segment of the eurozone architecture further.

Finally, we could imagine that the ECB advances Euro internationalisation by extending its network of swap lines. In the Offshore US-Dollar System, central banks are among the most capable players and de facto take on responsibilities for foreign and economic policy. The Federal Reserve, via its swap lines, has demonstrated its willingness to stabilize offshore US-Dollar creation in the event of a crisis and has made this type of institutional solution more attractive internationally. Transferred to Europe, the ECB could set up a structure of international swap lines that extends its function as a lender of last resort to other monetary jurisdictions in order to provide targeted incentives for offshore money creation denominated in Euros.

This proposal for EUR swap lines by the ECB sounds interesting. Are there models for it? Do you think such an approach is realistic?

The ECB already has a number of swap lines. On one hand, there are those with the major international central banks, such as the Fed and the Bank of England but also the People’s Bank of China. However, the main objective here is to ensure that the Eurosystem has enough foreign currency in case of crisis. Second, since the Eurocrisis, the ECB has established swap lines with Denmark, Latvia, Poland, Sweden and Hungary. These swap lines are certainly more concerned with ensuring that the central banks of these countries can stock up on Euros, if needed.

With the design of its swap lines for Poland and Hungary, however, the ECB has not exactly made offshore Euros attractive for companies and banks in these countries. Its approach to granting swap lines to smaller partner countries differed significantly from that of the Fed. When granting swap lines, the ECB did not accept the respective foreign currencies (Złoty and Forinth) as collateral, as the Fed does with its swap lines. Instead, it only lent euros against collateral that was already acceptable in the ECB collateral framework. This is more akin to the FIMA facility which the Federal Reserve introduced at the end of March, through which it lends US-Dollars against US government bonds. In other words: where the Federal Reserve generously provided banks with liquidity, the ECB was much more cautious. If the policy objective is indeed to encourage the private use of the Euro offshore, the ECB could consider introducing swap lines for certain currency areas and accepting the reserves of the respective central banks as collateral. That would be an effective and also relatively realistic policy measure.

With Trichet’s ECB twelve years ago, this would have been hardly conceivable. However, since Mario Draghi’s “Whatever it takes”, the ECB has in a sense reinvented itself and practically reinterpreted its mandate. It has thus given itself considerably more room for maneuver. Most recently, this transformation culminated in the Pandemic Emergency Purchase Program (PEPP), which was adopted in March, updated this week, and once again significantly changed the ECB’s collateral framework. It looks as if such a policy would be much more realistic under the aegis of Christine Lagarde—at least as long as the German Federal Constitutional Court plays along.

Thank you for the interview!

[1] See for example Benjamin J. Cohen, The Geography of Money (Ithaca and London: Cornell University Press, 1998); Philipp Hartmann and Otmar Issing, ‘The International Role of the Euro’, Journal of Policy Modeling 24 (2002): 315–45; oder Barry Eichengreen and Masahiro Kawai, ‘Introduction and Overview’, in Renminbi Internationalization. Achievement, Prospects, and Challenges (Washington, D.C.: Brooking Institution Press, 2015).

Picture Credit: Heritage Auctions