Review of International Political Economy 15:3 August 2008: 439–459
A rivalry in the making? The Euro
and international monetary power
Kathleen R. McNamara
Department of Government and School of Foreign Service,
Georgetown University, Washington, DC 20057, USA
ABSTRACT
Over the past few years, the dollar has been trading at historically low values
against the Euro. Does the current trend indicate that the Euro is poised to
challenge the long global supremacy of the American greenback? And how
might currency rivalry reflect and shape the broader balance of power between the United States and the EU? The approach to the general relationship
between power and currency is discussed, the determinants and characteristics of a key currency assessed, and the advantages and disadvantages that
accrue to a key currency nation briefly reviewed. The current, and likely future, state of play in the global usage of the dollar, the Euro, and other major
currencies are sketched out, stressing the interaction of material factors and
the role of ideas and social processes in determining key currency status. On
balance, the essay concludes that the Euro has many of the underlying economic factors that would make it a peer competitor to the dollar, but that the
necessary political power and social requirements are missing to make it the
focal point of the global economy. Nonetheless, observers of the transatlantic
relationship should be on watch for indicators of a possible transformation
in the Euro–dollar relationship.
KEYWORDS
European Union; Euro; dollar; power; constructivism; geopolitics.
Over the past few years, the dollar has been trading at historically low
values against the Euro. Although ‘historic’ is somewhat hyperbolic term
as the Euro is still a young currency, the Euro’s rise against the dollar has
been dramatic enough to capture the attention of pundits, policymakers,
and publics alike. Whereas in January 2002, it cost Americans only 86 cents
to buy one Euro, by July 2008, those paying in dollars had to hand over
the relatively princely sum of $1.59 for the European Union’s (EU) single
currency.1 To make matters worse, the dollar’s bumpy ride unfolded in
Review of International Political Economy
C 2008 Taylor & Francis
ISSN 0969-2290 print/ISSN 1466-4526 online http://www.tandf.co.uk
DOI: 10.1080/09692290801931347
R E V I E W O F I N T E R N AT I O N A L P O L I T I C A L E C O N O M Y
front of a backdrop of ever globalized capital markets, causing pundits on
both sides of the Atlantic to warn darkly of the potential for widespread
financial disaster if investors, particularly in Asia, decided to dump their
vast dollar holdings.2 Others argued over whether the reversal of currency
fortunes was a signal of the waning of US power and the rise of the EU.
In contrast, the Bush Administration only seemed willing to engage in
‘cheap talk’ to halt the dollar’s slide, possibly viewing the dollar’s decline
as politically unworrisome – and potentially even economically beneficial
should a cheap dollar cause more American goods and services to be sold
abroad.
Who is right? Does the current trend indicate that the Euro is poised to
take over the long supremacy of the dollar, with a damaging financial meltdown possible during the transition? Or is US monetary supremacy likely
to remain unchallenged?3 Does the fate of the Euro–dollar relationship reflect, or perhaps itself shape, the relative geopolitical power positions of
the US and the EU? In this essay, I systematically address the question of
whether the Euro will challenge the US dollar as the key currency of the
international monetary system. The fate of the dollar, the central question
of this special issue, is inextricably linked to the Euro, as it is presently the
only viable currency alternative to the greenback. Investors have to put
their money somewhere if they pull out of dollars, impressionist paintings and Polynesian atolls not being liquid enough assets to substitute for
currency. I argue, however, that both the alarmists and the Bush administration have it wrong. The sky is not falling, but nor should the US remain
complacent about the inevitability of the dollar’s exalted position in the
international political economy.
Simply put, my argument is that the foundations of political power, and
their embodiment in social processes, are not adequately developed in the
EU case to allow the Euro to overtake the dollar as the international currency of choice. Thus, the dollar is not likely to end up on the junk heap of
history anytime soon. However, actions on both sides of the Atlantic could
push the EU towards a more powerful and more unified political stance
in both the international economic and global political order, potentially
increasing investor preferences for the Euro. Current EU policy is officially
neutral regarding the international use of the Euro, and privately, some EU
policymakers worry about the perils and pressures of being the key international currency. But if the EU does increase its political integration and
institutionalization to the point where it can more readily project power
globally, the Euro is likely to quickly overtake the dollar and gain key currency status. If the US simultaneously continues on a path of economic and
political overexpansion of its own, a particular combination of European
and American policies could well provoke a cascade of investor unease in
the dollar. US policymakers would therefore be wise to not rest assured
that their currency unipolarity will continue indefinitely.
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The potential for Euro–dollar rivalry is an important question not only
for policymakers and investors, but also for scholars of political economy.
In the words of Robert Gilpin, ‘Every international monetary regime rests
on a particular political order’ (Gilpin, 1987: 119). A monetary order is a
function of the underlying political power distribution but is also a tool for
actors within the existing system to either prolong or subvert that order.
Money is inherently subjective: its value and meaning are not intrinsic but
constructed, both socially and through political power. An examination of
the shape of the rivalry between the dollar and the Euro can therefore also
inform our understanding of the sources of currency hegemony and the
likely path of the EU’s development as a geopolitical actor.
The rest of this essay proceeds as follows. I first discuss my approach
to the question of power and currency and situate it within the rich international political economy literature on the topic. I then assess the determinants and characteristics of a key international currency, and briefly
review the advantages and disadvantages that accrue to a nation holding
a key currency. I sketch out the current state of play in the global usage
of the dollar, the Euro, and other major currencies, and analyze the likely
path of the Euro and the dollar. I stress in particular the interaction of
material factors and the role of ideas and social processes in determining
key currency status. The conclusion argues that the Euro has many of the
underlying economic factors that would make it a peer competitor to the
dollar, but that the necessary political power and social requirements are
missing. Nonetheless, observers of the transatlantic relationship, and of
globalization more generally, should be on watch for early indicators of
the potential transformation in the current currency order.
P OW E R A N D C U R R E N C Y
Even a casual observer of the history of modern currencies is likely to note
a strong empirical relationship between currency dominance and geopolitical power. The US dollar in the second half of the twentieth century, and
the British pound at the end of the nineteenth, are widely regarded as the
key currencies of their eras.4 I define key currency broadly, as the currency
that dominates across a variety of functions: namely, the national money
held most widely outside its own borders by both private actors and public authorities, used in the majority of cross border transactions around
the world, and most frequently purchased in the form of various financial instruments such as bonds. The key currency is also the one money
that other states most often anchor or peg their own currencies to in either
formal exchange rate regimes (such as the post war Bretton Woods system, centered on the dollar) or in unilateral decisions to try to follow the
value of the key currency (such as Argentina pegging to the dollar in the
1990s).5
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The US and Britain have both served as the geopolitical hegemons of the
international system during each time period of their key currency dominance. Scholars of hegemonic stability theory have explored the linkages
between the concentration of power in one state in the international system,
and the degree and nature of economic globalization in that system, arguing that hegemony promotes openness (Gilpin, 1987; Keohane, 1980; Krasner, 1976).6 A strand of this literature argues that a single, dominant hegemonic currency is an essential part of this globalized political order, as investors and those engaged in trade are presumed to need to the confidence
and convenience of a widely accepted and legitimate currency for international markets to flourish (Cohen, 1994; Kindleberger, 1973; Ruggie, 1982).
The experience of several competing currency blocs in the notoriously unstable interwar period has led many scholars to conclude that one, unique
key currency contributes to stability in the international economic system.
For the state issuing it, the status of key currency is one that potentially
carries enormous benefits, but also potential costs, manifested in both internal and external ways.7 One critical benefit is that the hegemonic currency
state may have a much larger leeway for its own macroeconomic policies
because it will not have to adjust to international markets to the same degree as other states (Cohen, 2006). For example, the US over the postwar era
has had a much easier time financing its balance of payments problems,
and deferring economic adjustment while living beyond its means than
other states (Cohen, 1977; Gilpin, 1987; Kindleberger, 1970; Kirshner, this
volume; Strange, 1971). This is largely because investors continue to seek
out dollars regardless of its short term economic fundamentals or valuation on international currency markets, but rather because of its status, and
thus usefulness, as key currency. US debt therefore has been sustainable
in part because many investors prefer to remain in the system’s central
currency. This macroeconomic leeway is predicated on the maintenance of
confidence in the key currency, however.
More room for maneuver is also created when the currency is internationally hegemonic because the hegemon’s policymakers do not need
to pay close attention to drops in its value, as policymakers know that
there will always be buyers for the key currency, as long as there are
limited viable alternatives. The potential for this sort of increased independence and autonomy from the constraints of the international economy system thus enhances the power of the lead currency state. In
addition, seinorage, or the difference between the costs of producing
cash and coins and the actual face value of the money, brings in additional revenue to the key currency government. Because such a high proportion of dollars issued by the Federal Reserve today (approximately
75% by some estimates) circulate outside the United States, the US has
netted significant sums for its national treasury through this seinorage
process.
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Currency can also reinforce certain foreign policy goals if it buttresses
state power. Cohen (1998) argues that having the dominant international
currency projects the hegemonic state’s identity abroad, an example of the
exercise of ‘soft power’. Having your currency used as the lingua franca of
international finance and business may enhance international prestige and
status, reinforcing the perception of economic and geopolitical supremacy.
Finally, a dominant currency may bring with it the potential for use in
specific exercises of hard monetary power. Kirshner (1995) has demonstrated how hegemonic states have manipulated international monetary
relations to advance their security goals, through the creation of monetary
dependence on the part of weaker states, by manipulating exchange rate
values, or through system-wide disruptions of the international financial
order.
Notwithstanding these advantages, key currency status also presents
risks and challenges that may create a serious downside, one less examined
by political economists. For every advantage noted above, there is a related
risk as well. Most generally, international usage of a national currency
brings with it the potential for loss of control over many aspects of monetary
policy and currency use. The value of a currency is difficult to stabilize if
vast holdings are in the hands of other governments in the form of foreign
exchange reserves, debt instruments, or as currency circulating outside of
your national borders, such as in the case of the dollarized economies of the
world. As financial markets continue to increase in size, this loss of control
may snowball as if a central bank is not able to shape market participants’
perceptions of value in the manner desired by policymakers. Confidence
in the economic and political stability of a hegemonic state is crucial, but
the existence of a rising challenger may erode the sense of invincibility. For
all these reasons, key currency status if not necessarily an unconditional
benefit to the issuing state.
WHERE WE ARE
Before analyzing whether the Euro will muscle out the greenback, we first
should take a snapshot look at where the Euro is today vis-à-vis the dollar
and other leading currencies.8 The official data from the Bank for International Settlements (BIS), the clearinghouse for the world’s central banks,
and the data from the national central banks themselves, always lag by a
year or more at the very least. In addition, data on foreign exchange reserves are often closely guarded by central banks. Nonetheless, we can start
to get a picture of change over time in the Euro’s use. There are several different ways of measuring the prominence of a currency in the international
economy. One is to look at the relative proportion of each currency that is
held by national central banks, which will normally hold the majority of
their reserves in those foreign currencies believed to be the most stable,
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Table 1 Global foreign exchange market: official FX reserves (percentage of world
total)
US $
Euro
Jap. yen
Pound St.
Swiss Fr.
Unspecified
1999
2000
2001
2002
2003
2004
2005
2006
70.9
17.9
6.4
2.9
0.2
1.6
70.5
18.8
6.3
2.8
0.3
1.4
70.7
19.8
5.2
2.7
0.3
1.2
66.5
24.2
4.5
2.9
0.4
1.4
65.8
25.3
4.1
2.6
0.2
1.9
65.9
24.9
3.9
3.3
0.2
1.8
66.4
24.3
3.7
3.6
0.1
1.9
65.7
25.2
3.2
4.2
0.2
1.5
Sources: For 1999–2005, European Central Bank, ‘The Accumulation of Foreign Reserves’, Occasional Paper Series 43 (February 2006); for 2006, International Monetary
Fund, Currency Composition of Official Foreign Exchange Reserves (COFER), accessed at
http://www.imf.org/external/np/sta/cofer/eng/cofer.pdf. See also European Central
Bank, Review of the International Use of the Euro (2007: 44).
desirable, and readily exchangeable. Data on the reported official foreign
exchange reserves held by national central banks, above, show that while
the dollar is nearly two-thirds of all reserves, the Euro has been gaining
ground since its inception.
Currencies are also used as accounting devices, or ‘units of account’
so as to have a common term to denominate disparate monetary flows.
Logically, such units of account invoicing should track the direction of
trade, and they do, with some important exceptions. In the invoicing or
pricing of international trade transactions, the dollar has been used in the
accounting of almost half of all world exports, which is more than double
the US’s share of actual trade, indicating that commercial actors are using
dollars to price their goods and services even if the US is not a party to the
transaction.
Comprehensive cross-national data on invoicing is scarce. A recent report for the Group of Thirty by Goldberg and Tille (2006) offers the broadest
survey, and the following information is drawn from their work. The US
and the Eurozone countries use their own currencies most frequently, unsurprisingly. An overwhelming 99% of the US’s own exports, and 92% of
its own imports, were priced in dollars in 2003 (Goldman and Tille, 2006).9
In the Euro area, the Euro is less dominant, and there is some variation
across states: in exports the highest share of dollar invoicing is found in
Greece (46.1% in dollars, 47.3 in Euros) and the lowest dollar, highest Euro
invoicing is in Italy (17.5 and 74.9%, respectively). The new EU member
states in Eastern and Central Europe generally use Euros for invoicing
more than the Eurozone states themselves: for example, Slovenia in 2003
used Euros for 86.9% of its export financing, and Hungary for 83.1%. In
contrast, Estonia, long a staunch US ally with a more distinctively neoconservative stance, invoiced only 8.5% of their exports in Euros, and 70.4 in
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dollars. The UK uses pounds for much of its invoicing, and splits its export
invoicing between the dollar (26%) and the Euro (21%).10
More relevant to the question of Euro–dollar rivalry, perhaps, is the question of what third countries, who do not themselves issue one of the world’s
top currencies, use. In Asia use of the Euro lags far behind the dollar, with
the major states of Asia not breaking double digits for Euro usage in export
invoicing, preferring dollars instead. The exception is Japan, which uses
its own currency in equal parts to the dollar, with Euros used in almost
10% of export invoicing.
Unfortunately, only anecdotal data are available for those third countries
that might be most interesting, politically, to consider. There are has been
some discussion on the part of national governments particularly those in
the Middle East, unhappy with the Bush Administration’s foreign policies,
to move to using Euro’s to denominate trade. In a particularly high profile
case, Cohen (2003a) reports that Saddam Hussein chose to begin invoicing
Iraqi oil exports in Euros in 2000 and converted their UN reserve fund into
Euros, and that Iran and other Middle Eastern states have been considering
similar actions.
Global bond markets are the one area that Euro is now dominating the
dollar, but only by some measures. These bonds are notes issued by both
public bodies (national and subnational governments), private companies,
and financial institutions for the purpose of borrowing money on international financial markets. By one account, in 2006, such Euro-denominated
bonds made up 45% of total outstanding global debt in international markets, surpassing the level of dollar-denominated debt, which was at 36%
(International Capital Market Association, 2006). This Euro dominance
marked the second year in a row that the European currency was the
most frequently used denomination for international market bond instruments.11 This change has occurredrapidly. Within a few years of its creation,
the Euro was being used in about 30% of all new bond issues, while the US
dollar was used in 44%, and the yen 13% (ECB, 2002). It appears that the
bulk of the new Euro issues are coming from private actors. This development seems in part due to the deepening of European capital markets,
promoted in part by a move away from the traditional European model
of bank financing, and more stable interest rates in the Eurozone than in
the US (Oakley and Tett, 2007). Finally, there also seems to be a trend of
Europeans moving away from buying American Treasury bills, leaving
it to Asian central banks to hold US debt (Forbes, 2004). This interest in
Euro-backed financial instruments is one important indicator of a growing
confidence in the EU on the part of investors.
In sum, the Euro is a fast developer, performing at a level far beyond its
age; however, the US dollar still dominates across a range of currency indices. Should we assume that this will continue to be the case? Or is the Euro
likely to continue its upward trajectory, eventually displacing the dollar?
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To make predictions about this, we need to develop an analytic framework
for understanding the determinants of key currencies and evaluate these
factors in the case of the Euro. This we accomplish in the next section.
T HE S O C I A L S O U R C E S O F C U R R E N C Y H E G E M O N Y
Despite the compelling imagery of Adam Smith’s ‘invisible hand’, to understand the sources of currency use, it is critical to note that markets have
never been neutral mechanisms unfolding in some impersonal void, but
rather are themselves constructed out of political and social understandings and relationships (Dobbin, 1994; Fligstein,1996; Granovetter, 1985;
Swedberg, 2003). This is as true for global markets as it is in the domestic realm (Hay and Rosamond, 2002). Money stands out as a particularly
striking embodiment of the importance of the role of social expectations
and the creation of meaning in market construction (Best, 2005; Gilbert and
Helleiner, 1999; Leyshon and Thrift, 1997; Simmel, 1978; Widmaier, 2004).
Thus, it is necessary to consider the political and the social underpinnings,
as well as the economic determinants, of money and international currency
choice. To develop a simple analytic framework for doing so, I drawn on
the convention of thinking about money in terms three key functions it
performs: as a unit of account, a means of exchange, and a store of value.
Evaluating the socially constructed dynamics of each of these functions
demonstrates the intertwining of power and perceptions in currency value
and use, and provides guidance as to the future of the Euro.
The most straightforward function that money serves is as a unit of account. This function can be achieved by any numerical system that can be
used to denominate value, as long as it is agreed on by all those participating in a transaction or series of transactions. The dynamic driving the
development of a unit of account is similar to the need to develop a focal
point around which players can coalesce in a coordination game: it doesn’t
matter as much what option is chosen but rather that all participants agree
on it. Agreement is easiest when participants share a common cultural
context, and worldview, which allows for mutual social recognition of a
solution (Schelling, 1960).
In international finance, the existence of such a focal point creates significant advantages for market participants. Widespread social recognition
of a single, key currency allows for a clear unit of account that creates
economies of scale and positive network externalities – in other words,
the more people who use the currency as a unit of account in transactions,
the more effective it is as a universal currency.12 A focal point is easier to
achieve when it is perceived by actors as both obvious and unique given
a certain social or cultural context. Schelling (1960) famously undertook
an experiment where he asked people where and when they would meet
another person in New York City it they could not coordinate beforehand.
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The overwhelming answer was that they would converge at noon in Grand
Central Station at the information booth, an answer driven by culturally
influenced expectations about what the other actor would do. In essence,
the social construction of what is rational in that particular social time and
place, not the functional utility of that particular meeting place, drives the
solution. For example, the notion that noon is a natural time to meet is
reliant on a shared conception of time. Artists who work all night, dairy
farmers up before dawn, or aboriginal natives living by the movement of
the sun would presumably come up with different notions of what constitutes a natural meeting time. The point is that these expectations are
inseparable from the social context in which the action takes place, even
though they may appear natural to us within the particular context.
The corollary in international finance might be that market actors seeking
a standard unit of account are likely to converge on that currency that
they believe others will also view as the ‘natural’ dominant currency. The
social construction of a financial focal point would, within our particular
international political culture, be most plausibly be linked to the nation
which has economic and political heavyweight status in the international
system.13 Here the US dollar has clear advantages over all other currencies,
as it belongs to the dominant superpower of the postwar era, creating a
focal point for actors in the global economy.
The development of the EU as a united foreign policy actor, still very
much a work in progress, would be necessary for the social construction
of such a new focal point across global market participants. But even if the
EU makes significant moves forward in the foreign policy realm, there is a
stickiness to focal points as shared expectations become institutionalized
formally, or informally, creating social structures that can prove slow to
change, even should the EU cohere as a political actor. The impetus for
change needs to be strong or social actors will merely continue to use the
convention or practice that has developed over time – even if the booth
is removed from Grand Central, travelers are likely to continue using its
old location as their meeting point for some time. For a currency serving as a unit of account, familiarity of use and ease of coordination are
paramount properties, and the Euro as a new currency still must establish
itself in the minds of market participants. Social structures are robust, but
they are also dynamic, as they are continually created anew by the subjective understandings of the actors that constitute them. Thus there may be
certain thresholds that could create social tipping points and induce a cascade of changing expectations that could quickly lead market participants
and public officials out of the dollar and into the Euro.14 US policymakers
should remember that if social conventions and cultural understandings
are indeed the mechanism that produce the focal point of the international
unit of account, should actors in the global economy decide to move to
using the Euro for their accounting, there are few material barriers to them
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doing so. In this way, the ‘hard landing’ scenario of a dollar crash could
indeed unfold.
The other two functions that an international currency must successfully
fulfill, that of a means of exchange and a store of value, have somewhat
more complex requirements than the relatively simple focal point logic of
the unit of account. In these functions, the confidence with which the currency is perceived as a reliably liquid instrument for financial transactions,
and whether investors are confident that the currency will be relatively
stable or increasing in value, are critical. This confidence, in turn, is most
likely where the national economy has a record of low inflation and steady
growth. It also is most likely when the key currency’s national financial
markets are robust, efficient, and deep, and liquid portfolio investment
opportunities are readily available. Political and social factors may be crucial, however, in providing confidence as they shape private actors perceptions about the inherent value and sustainability of all of these economic
elements.15
The US is widely viewed as having the most liquid and deep financial
markets in the world, making the dollar an attractive currency for transactions. The US also has had a long term growth record which has outpaced Europe, particularly in the last decade, where EU real GDP growth
has been a disappointing 2%, on average, versus the US’s more than 3%
growth. Many observers believe that the EU’s Stability and Growth Pact
(SGP) budget deficit limits, although not strictly adhered to, will continue
to dampen growth prospects. All of these factors feed into the perception
of the dollar as the most attractive means of exchange and store of value
internationally.
These differences with the US may be eroding, albeit very slowly. The
EU recently has begun to make financial integration within Europe a top
priority, as the last sector to be tackled to produce a truly integrated single market (Jabko, 2006). However, the flow of money across Europe is
hampered by a nationally based regulatory structure within the EU. The
harmonization of rules regarding securities, banking, and insurance are
now under review by the so-called Lamfalussy framework, which was
set up in 2001 to move forward financial integration, is now under review by EU finance ministers (Posner, forthcoming). The current nationally divergent rules make it more difficult to take advantage of the size
of European market, which in pure numerical terms exceeds that of the
US, and establish trans-European financial instruments. Progress has been
made in some areas of EU financial infrastructure, as Europe has reduced
the number of payment settlement systems, although there are still more
layers of systems for the settlement of transactions than in the US. Overall, Europe is still some ways to matching the financial depth and efficiency of US markets, although they seem to moving down such a path
(Posner, 2007).
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An additional major barrier to the Euro’s rise as a key currency, with
all its ancillary political benefits, is that there is no equivalent to the US
treasury bill at the level of the European Union. The EU institutions are
prohibited by current treaty law from floating debt, and thus there is no single financial instrument backed by the collective, institutionalized federal
weight of the EU. Instead, there has been competition among EU member
states to have their own national financial instruments gain status as the
Euro ‘benchmark’ bond. As we have seen, the Euro has surged passed the
dollar in terms of bond denomination, but only through national governments’ and private actors’ debt. Without a EU treasury bill to match the
American T-bills, Euroland’s political and economic weight will not be as
readily transferred to the Euro. The Euro will therefore likely remain a less
attractive currency than the dollar in overall terms. Most importantly for
our analysis, the EU will thus be less able to reap the ‘exorbitant privilege’ of key currency, because it will not have the EU level deficit financing
abilities that accrued to the dollar over the postwar era.
More subtle perceptual determinants of currency leadership also play a
role in making the Euro less likely to challenge the dollar in the immediate
future, while still allowing for the potential for transformation in the long
run. Many of the economic factors discussed above are strongly influenced
by the presence or absence of confidence, arising in part from expectations
of future stability and value. These perceptions are heavily influenced by
the political status and profile of the lead currency country, in interaction
with cognitive and normative processes that work to create meaning for
actors. The phenomena that drive these processes have to do with issues of
trust, symbolism, and communication as much as they do with economic
fundamentals.16 Just as in the case of the focal points and unit of account
example, a currency is likely to be viewed with more confidence when it is
produced by the leader of the international system, as long as that leader
is perceived to be both willing and able to stabilize the system. How do the
US and the EU stack up along these more perceptual criteria for currency
confidence?
While the US has hardly had a perfect record of providing stability to the
international monetary system, it is clearly the dominant political player
in the global political economy. It has by far the most resources and institutional footing in the IMF and G-8 to carry out, even if imperfectly, crisis
prevention and resolution, should it desire to do so. The panoply of Bretton
Woods institutions, after all, were set up in the US’s image and structured
with America at their center (Helleiner, 1994; Ruggie, 1982) reinforcing
the identification of the US with system leadership. In contrast, the EU is
hampered in this arena of confidence and social understanding, because
of its unique status as a para-state, a loose federal system with some of the
qualities of sovereign statehood but without the institutional and political
capacity to speak with a single voice or act with alacrity in an international
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financial crisis. Investors presumably have as hard a time as scholars in categorizing the EU as a political actor, and the confidence with which they
view the Euro will be weakened by the mismatch of a powerful currency
representing a large proportion of the world’s GDP without a concurrent
unified political entity (McNamara and Meunier, 2002).
Uncertainty over how intra-EU disputes and systemic crises will be handled persists, potentially weakening confidence in the Euro. The ECB does
not have supervisory capacity similar to the Federal Reserve over the EU
financial markets, even as those markets become more closely linked. The
Maastricht Treaty has language about EU oversight for the ‘smooth operation of the payments system’ meaning TARGET, the intra-European large
payments system, for which the ECB could be a lender of last resort in the
event of a crisis. But outside this, the treaty is silent, and its authority over
broader financial crises is the source of hot debate among legal scholars.
Ambiguity and uncertainty may help with the moral hazard problem of investors assuming they will be bailed out, but it may make markets nervous
about where the buck ultimately stops, making the Euro potentially less
attractive as the global key currency.17 The ECB has a very good reputation
for guarding the stability of its currency, and was widely praised for its
actions in calming turmoil in the financial markets in the period following
August 2007. While this is a very positive development, the ECB’s ability to
serve the broader financial health of the EU, and the international system
as a whole, remains untested.
E U R OP O L I T I C S I N P R A C T I C E
Finally, while the structural features discussed above, be they political,
economic, or social, all contribute to the future path of the Euro, what of the
Europeans themselves? Have EU actors promoted the use of the Euro, with
an eye to presumably shoring up their global power in the process? Despite
a longstanding presumption that this was an interest on the part of some in
the EU, particularly the French government, the answer is largely no, at this
point. There seem to be few constituencies within the EU that are publicly
advocating for an explicit increase in the Euro’s international role. Recent
remarks by Lucas Papademos, Vice President of the ECB, in November
2006 reflect the consistent statements by ECB officials that international
use of the Euro is something to be determined by markets, not the EU’s
policy actions.
The ECB considers the global use of the euro as a market-driven process that reflects all the factors influencing the preferences of global
market participants and non-euro area authorities with regard to
the functions it performs. So, we have a ‘neutral’ view on the international role of the euro. Nevertheless, we carefully monitor and
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analyze pertinent developments in order to better understand the determinants of its global use and potential implications for the ECB’s
monetary policy. (Papademos, 2006)
Inside the ECB, there also seems to be little support for pursuing a global
role among staff when asked for ‘unofficial views’.18 The emphasis of many
central bankers is on the domestic European position of the Euro, and on ensuring its stability and success (economic and political) as a young currency,
in particular by strengthening the institutions of Euroland governance. The
transition of the Euro into an important international currency, should it
occur, is viewed by some staff as dangerous and potentially costly. They
mention, for example, that a Chinese decision to switch into Euro reserves
would promote a huge appreciation of the Euro, one not manageable by
the ECB and potentially damaging to the EU trade balance. Other such
markers of a key currency, such as massive amounts of Euros circulating
outside the Eurozone as dollars do today outside the US, are viewed by
some at the ECB with alarm. For some policymakers in Frankfurt, such
Euro adoption puts as them in an unenviable position of loss of control.
The recent adoption of the Euro as the currency of choice in the Western
Balkans, for example, was noted as something that the ECB would not
discourage, but would by no means actively push.
Other actors in the European policy arena, such as the Commission, also
seem reluctant to advocate strongly for an increased role for the Euro. This
is somewhat curious, given the Commision’s role historically has most often been to pursue policies that expand the EU’s perceived power. Inklings
of an awareness among EU officials of the potential benefits of the Euro
as the world’s key currency are indeed present. The decision of the ECB
early on in its existence to issue very high Euro denominations (200 and
500 Euro notes) has been argued to be a function of policymakers desire to
promote the Euro as a means of exchange, even if it is likely to be exchange
of an illicit sort (Rogoff, 1998). The EU Commission also negotiated with
computer manufactures early on to promote the placement of Euro symbols as standard on keyboards, along with the dollar. And there is some
discussion about promoting the use of the Euro in the Middle East, as the
transatlantic divide sharpens over the appropriate foreign policies in that
region (Cohen, 2003a). However, there is little consistent action on the part
of the Commission, and the independence of the ECB and the lack of clarity
over who is responsible for exchange rate policy (the Council of Ministers
or the ECB), acts as a further damper on such efforts.
In fact, a related marker of the reluctance of Europe’s political elite to converge on a policy of a strong international role for the Euro is this continued
lack of streamlined external policy structures for the Euro (McNamara and
Meunier, 2002). The EU continues to drag its feet on consolidated external
representation in international fora, and as who exactly has authority over
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exchange rate policy within the EU is itself ambiguous, effective projection
of the Euro as a international currency remains problematic. However, all
of these issues are far from insurmountable, and if the EU member states
and policymakers within EU institutions decide they wish to strengthen
investors’ confidence in the position of the Euro as an international currency, policy and regulatory changes could be effected to readily deal with
all of them.
Instead of explicitly focusing on the Euro’s international use, debate over
the value of the Euro vis-à-vis the dollar has been the primary touchstone
of contention in the national capitals.19 These debates in some ways might
be read as linked to the broader question of international monetary power
and questions of the desirability of insulation, control and stability. In 2006,
the French presidential campaign included discussions about the role of an
overvalued Euro in worsening European trade balances. In contrast, certain
German officials, notably German Finance Minister Peer Steinbrueck, in a
statement on 11 January 2007, have been advocating for a continued strong
Euro, as a sign of stability and value. In that speech, Steinbrueck gave a rare
public endorsement for the promotion of the Euro as a reserve currency, a
stance notable for how unusual it was. It is likely that such tensions over
the exchange rate will continue unresolved for the foreseeable future.
The status of the Euro will not be determined solely by the EU’s policy
activities, however. US foreign economic policy will of course also play a
large role in whether the various functions of international money shift
into Euros.20 The official policy of the US under the Bush administration is
simple, and has remained relatively consistent, in rhetorical terms at least,
through three different Treasury secretaries. Speaking at the end of 2006,
a Treasury spokesman stated: ‘The administration’s policy on the dollar is
unchanged . . . A strong dollar is in the national interest. Currency values
should be set in open, competitive markets’ (Kruger, 2006). Likewise, as
the dollar continued to fall against the Euro, Treasury Secretary Henry M.
Paulson Jr. drew from the same script to say ‘A strong dollar is clearly in
our nation’s best interest’ (Weisman, 2006).
Yet, many experts and financial market participants dispute the commitment to this position, and rather see US policymakers and politicians
as focusing more on the potential trade benefits from dollar weakness,
rather than on fearing financial instability from dollar weakness. Dollar
diplomacy in practice has largely been centered on public critiques of
China for the undervaluation of its currency, implying that the US dollar should, in fact, weaken against the yuan. The stated hope is that this
would move the trade balance more in the US’s favor. Tepid rhetorical defenses of a strong dollar aside, US officials have called in international fora
only for the EU to undertake structural reforms with the presumed effect of
stimulating growth, rather than focusing on the Euro–dollar relationship
explicitly.
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Indeed, through its broader macroeconomic policies the Bush administration has demonstrated that a strong dollar is not a high priority. In search
of other policy goals, both domestic and foreign, the Bush administration
has presided over a dramatic reversal of the federal budget from a surplus
of $250 billion in 2000 to a deficit of over $400 billion in 2004, shrinking to
$248 billion in 2006, according to the Congressional Budget Office. A concurrent ‘twin deficit’ in the current account has arisen, and in 2006 stood
at over $200 billion. These fiscal developments are likely to have been a
major contribution to the weakening of the dollar. On the other hand, the
dollar has been cushioned by the continuing superior growth of the US
economy, and the continued accumulation of dollar holdings on the part
of China and other Asian nations. In Washington, it seems apparent that
there is little support for reining in domestic US spending when the fears
of a ‘hard landing’ for the dollar are far off.
Likewise, there seems to be little publicly expressed fear in Washington
that the Euro represents an economic or political challenge to the dollar
and the US more generally, despite popular sentiments to the contrary.
Views inside the Beltway seem to be that the EU ‘can’t get its act together’
enough to mount a true challenge to US monetary unipolarity. In the early
days of Economic and Monetary Union (EMU), a deep strand of skepticism
seemed to mark both economic and foreign policy circles, most famously
in Martin Feldstein’s Foreign Affairs article suggesting that the Euro would
be likely to create serious intra-EU and transatlantic conflicts (Feldstein,
1997). Now, US officials and foreign policy think tank members are more
likely to discount the EU because of its relatively undeveloped foreign
policy apparatus, although paradoxically they persist in treating it as a
single actor in their debates over whether it is consequential or not. Some
US officials privately express frustration that the EU has not reorganized
its external representation in financial fora such as the IMF, realizing that
while it would increase the EU’s solidarity of purpose, it would also reduce the number of votes the EU countries would hold.21 In sum, both
the EU and the US policymakers seem reluctant to publicly address the
question of whether the Euro could or should challenge the dollar, and do
not seem to have developed coherent policies in support, one way or the
other.
CONCLUSION
The Euro has many of the economic advantages that investors are likely
to seek out in a key currency. A huge internal market, increasing financial
integration, and generally sound fiscal profiles all point to the Euro rising
to challenge the US dollar over the next decade. However, the political and
social determinants of key currency status are not yet met in the EU case,
giving a good deal of breathing room to the US dollar.
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A currency’s value and desirability are subjectively constructed, and investors act based in part on their expectations or perceptions about what
others will do. In the EU, a relatively fragmented regulatory system and
ambiguous decisionmaking power over financial and exchange rate matters is likely to make investors uncertain about exactly what sort of political entity the EU actually is – neither nation-state, yet not simply an
international organization. The history of international monetary orders
tells us that geopolitical power has been a necessary condition for key
currency status, in part, I have argued, because of the social expectations
that hegemony engenders, creating a robust focal point for investors. Despite some shaky numbers on the US side in trade and budget deficits,
and a dramatically depreciated dollar potentially pushing investors away,
it will take a big leap forward by the EU to craft the political and social
underpinnings necessary for monetary hegemony. The federalization of
the EU, particularly in the fiscal and foreign policy arenas, would potentially produce significant investor switching to the Euro. However, once
constructed, perceptions of status and value are sticky, and inertia remains a strong driver in shaping conventions and practices in international
monetary matters. Under conditions of uncertainty such as those that often plague financial markets, imitative behavior may be a highly rational
strategy, and this is likely to keep the dollar in its position of exorbitant
privilege.
Paradoxically, given the importance of political power for currency dominance, the dollar may be with us longer than unipolarity. Krugman (1992)
has noted that the British pound declined in its international use at a slower
rate than the actual slide of British economic hegemony, and both the
Byzantine solidus and Spanish silver peso were used long after the decline of the imperial powers that first coined them (Cohen, 2003b). Yet
should the EU decide to promote more aggressively the use of the Euro,
the causal link between power and currency may be reversed, as the quest
for a unified, strong Euro may force further political integration and institutional development in the EU. The interplay of power, currency, and
globalized financial markets is clearly ongoing in the twenty-first century
and its outcome, either way, will be consequential for both the EU’s and
America’s role in the world.
ACKNOWLEDGEMENTS
I thank John Ikenberry, Michael Mastanduno, Charles Kupchan and Jack
Snyder for their encouragement on early versions of this paper, as well
as members of the ECB staff for their generosity with their time and insights. The participants of the ‘Future of the Dollar’ workshop held at
Cornell University, 3–4 November 2006, provided invaluable comments,
particularly Herbert Zimmerman, Christopher Way, Eric Helleiner, and
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Jonathan Kirshner. I also thank three anonymous reviewers for their
helpful suggestions.
NOTES
1 The Euro’s trajectory has not only been upward, however, during its short history. When the participating EU national currencies locked their rates together
in January 1999, their new combined currency began trading as the Euro at
a value of $1.18 dollars on exchange markets, from which it sharply declined
down to 0.86 cents before it rose to substantially exceed its opening value.
2 For example, see Wolfgang Munchau, ‘Dollar’s Last Lap as the Only Anchor
Currency’, Financial Times, 26 November 2007; Larry Elliott, ‘US Risks a Downhill Dollar Disaster’, The Guardian, 22 November 2004; Jeffrey Garten, ‘Don’t
Let the Dollar Take the Fall’, New York Times, 7 December 2004.
3 Prominent statements by economists on the potential for the Euro to challenge
the dollar are Bergsten (1997) and Portes and Rey (1998), who answer in the
affirmative, and Cooper (1997) and McKinnon (1998), who are more skeptical.
A comprehensive political economy analysis, that also ends up doubtful of the
Euro’s rise, is found in Cohen (2003b).
4 Seminal contributions on this subject include Strange (1970, 1971), Gardner
(1980), Calleo (1987) and Cohen (1977). See Helleiner and Kirshner (this volume) for extended discussions of key currencies and their characteristics and
political determinants
5 I thus use the term ‘key currency’ to describe the overall, dominant currency
of the international system, encompassing the various uses and characteristics detailed above. Synonymous terms might be ‘global currency’ or ‘world
currency’. The key currency would include, as a subset, status as the international reserve currency, i.e. the currency most often held by governments and
institutions as part of their foreign exchange reserves. For a discussion of the
international reserve currency question, see Chinn and Frankel (2005)
6 For less benign views of the role of American hegemony in international finance, see Cox (1981, 1983)
7 For a thorough analysis of the benefits, but not the costs, of the key currency
status, see Cohen (2006). See Strange (1971) for a subtle and comprehensive
analysis of the British experience
8 There is a robust economic literature on the current Euro–dollar relationship; see in particular Lim (2006) and Chinn and Frankel (2005), Galati and
Wooldridge (2006), and Posen (2005) for comprehensive overviews of the data
that also include astute theoretical discussions. I do not attempt to replicate
those discussions here but rather focus on the international political and social
implications of these dynamics.
9 A comprehensive overview of the theoretical literature, and the empirical evidence on international invoicing, is found in Goldberg and Tille (2006). The
data that follow are drawn from this publication, prepared for the Group of
Thirty.
10 The ECB’s June 2007 report on the international role of the Euro comes to similar
conclusions on the use of the Euro in invoicing across Europe, emphasizing that
institutional arrangements (e.g. whether a country is an applicant to join the
EU) have a large impact on patterns of Euro usage (ECB, 2007).
11 The ECB’s most recent data, which take a narrower definition when measuring
debt securities, have Euro-denominated bonds trailing the dollar (ECB, 2007:
15).
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12 For an overview of network externalities arguments, which have some commonalities with the sociological argument I am making here, see Lim (2006)
13 See Wendt (1992) for a more general, social constructivist view of the nature
of power politics and relations in the international system; on American hegemony’s effects on the construction of the international monetary system, see
Leyshon and Thrift (1997) and Germain (1997). A helpful discussion of money
as a social fact is found in Searle (1995)
14 On cascading social expectations, see Finnemore and Sikkink (1998)
15 For example, see Carruthers and Babb (1996) for a through empirical analysis
of the social construction of monetary value in the post-bellum US.
16 An extended and thoughtful discussion of these issues can be found in Best
(2005)
17 Best (2005) convincingly argues that certain types of ambiguity have historically
been helpful for system stability. In contrast, confidence in leadership itself
would seem to suffer from such ambiguity
18 This conclusion, and the comments that follow, are based on a series of interviews with ECB staff, who agreed to speak only under the condition of
anonymity.
19 This is in addition to the ongoing debates over the Euro and EMU’s broader
effects on the national economies, mostly centered on the ECB’s monetary
policy and the SGP constraints on fiscal policy.
20 See Kirshner (this volume) for an extended discussion of US interests and the
dollar.
21 Bini Smaghi (2006), one of the ECB’s Executive Board members, offers a comprehensive review of the question of external representation, stressing the benefits
that would accrue to the EU if it consolidated its weight in such fora.
N OT E S O N C O N T R I B U T O R S
Kathleen McNamara is Associate Professor of Government and International Affairs at Georgetown University’s Department of Government and School of Foreign
Service. She is the author of The Currency of Ideas: Monetary Politics in the European
Union (Cornell University Press, 1998), co-editor of Making History: European Integration and Institution Change at Fifty (Oxford University Press, 2007) and has
published numerous essays on globalization, economic institutions and the role
of norms and culture in policymaking. Her current book project investigates the
social construction of political authority in the European Union. Dr. McNamara
has taught at Princeton University and Sciences Po (Paris), and has been a visiting
scholar at the Russell Sage Foundation, a German Marshall Fund Fellow, and a
Fulbright Fellow.
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