Paper no. 1597	04. 11. 2005
EURO AS CURRENCY OF REFERENCE FOR WORLD MONETARY TRANSACTIONS Guest Column by Hari Sud Reference currency is a tool for settling trade transactions. Today, it is the Dollar, before the WWII, it was British Pound. Since the Napoleonic wars of early eighteen hundred, gold standard existed. Since then the British currency was linked to gold i.e. a Pound Sterling will buy a fixed amount of gold. International trade transactions were settled in Pound. The gold standard permitted anybody with Pound to ask for an equivalent amount in gold.  The British central bank was bound by this obligation. Britain, after WWI, was barely ruling the waves, hence decided to exit out of the gold standard in 1933. The new world power, the United States of America, kept the gold standard but exited out, forty years later in 1971. Today, there is no country in the world, which adheres to the gold standard. Dollar is used as reference currency. All trade and other monetary transactions are settled in Dollars. Its reserves are pride and joy of a nation e.g. China has $500 Billion dollar reserve, India has about $145 Billion, South Korea, Taiwan and Japan are the other big holders of Dollar reserves in US. European nations since WWII kept their monies in their own central banks with some reserves in Dollars. With the advent of central bank of Europe in 1999, banking policy-making has shifted a bit but local central bank still lord over their monies. In last decade or so, Dollar has come under pressure. This is resulting in a fresh thought process to find another reference currency. What happens to Monies Which OPEC Nations Collect? Crude at $60 to $65 Dollar a barrel, sucks out money (in dollars) from the importing nations. At the moment, major OPEC nations are collecting roughly $45 Billion a month into its accounts. Sixty per cent of this money is collected from the developed world. Remaining comes from the developing or low-income world (China and India included). All these monies are retained in Dollars or in European currencies (today Euro). OPEC nations import goods and services from the West and pay off from these reserves. This maintains some balance. Surplus cash stays mostly in Dollar. When the oil prices shoot up, a bigger surplus is generated. At that time OPEC nations collect a bigger cash pile to spend. Poorer nations, which export less, are at a disadvantage when the prices rise. China has plugged up this disadvantage with consumer goods exports and trade surplus. India, Pakistan and other Asian nations with no trade surplus, send labor to work in the Middle East OPEC nations. Remittance from these expatriates is used to partially offset the disadvantage. In the West, rise in oil prices is neither boon nor a bust, although immediate impact is on the consumer, who complains about bigger fuel bill. As a matter of fact, higher crude prices create a bigger cash reserve at OPEC’s disposal. This makes them a bit spendthrift, which benefits the Western economies. In addition a bigger cash reserve in dollar allows the West to make more money available to the consumer at home or the businesses both abroad and at home. Hence when a consumer in New York buys a house and borrows money for it, part of the money is from the cash reserves of the other nations. The same is true about the businesses. In this way OPEC and the West are much more intricately tied to each other than we understand. The above (Petro-dollar) combined with a mountain of cash reserves of China, India, South Korea, Japan etc. are the mainstay of the US money supply. The other side of this cash equation is that US also lends this money abroad. In seventies it lent Brazil, Argentina, Mexico and South Korea close to $300 Billion. This continued until each of them overspent and came close to bankruptcy. It is now very cleverly invested in form of FDI in China, India and many other places.  Euro and its Prospects Europe has been divided by religion and ethnicity for the last two thousand years. It has a remarkable tendency to fight and then establish peace for the general being of its people and then fight again. The three hundred years are a remarkable period in its history. It fought bloody wars on a trifle and then invented the industrial revolution and advanced science and technology to what we see today. Their internal wars took a respite when Asia, Latin & South America and Africa, were discovered to be exploited. Monies from these continents were transferred to Europe to make them rich. Then over ambition lead to rivalry and rivalry lead to two great wars of the first half of the twentieth century. They exhausted themselves with death and destruction and decided to take a respite. The second half of the twentieth century witnesses no wars, hence prosperity returned. France and Germany the dominant powers on the continent Europe and Britain reluctantly decided to put their centuries old differences aside. They decided to combine their resources into one single market and a currency. First came the European Common Market (1958) and forty years later came the European Central Bank (1999) and a common currency “Euro” (2002). Common political system for the whole of Europe is about a century away. The combined economic might of all the European Common Market nations (excluding Russia) rivals the United States of America. This later fact does not sit well with US. Although US is generally supportive of the Europe’s effort to pool their resources together, they cannot see eye to eye with Europe on matters in which an economic rival could emerge. Hence Britain is their trump card. The latter is used to sabotage possible internal cohesion from within. Hence, Euro, although is a common currency of Europe, it cannot rival Dollar in its economic & political punch. US when the mighty Dollar is under threat could throw in its trump card i.e. its military machine. Europe, does not have a unified military under a politically stable command, hence it is at a disadvantage. This results in lesser weight given to the European viewpoint. Why Cannot Euro Replace Dollar in the Foreseeable Future? When Euro was launched in 2002, most felt that there would be a shift in the reserves of central banks of the EU nations. As a matter of fact a shift did occur, but it was relative to Deutsche Mark. Other nations outside the EU stayed away. Hence, it begs the question i.e. what advantages does the Dollar offer over the Euro, which prevents the shift. I can list a few: 40% of world’s business transactions today are conducted in Dollars, compared to 15% in Euro. Currently 65% of world’s reserves are held in Dollars, compared to only 15% in Euros. US economy is about 25% larger than the European Union. The population base of EU and US is approximately same at about 295 million. This disparity is the result of having weaker nations like Greece, Portugal, in its fold. US has a fairly homogenous and prosperous population base. Political segmentation prevents Europe from acting in a unified manner. This results in reluctance to deal with any monetary issue, no matter how important it is. Even introducing new banking products to attract cash reserves of other countries is reluctantly dealt with. Economic and monetary instruments exits in the US, which could suitably invest any country’s national holdings well. These facilities are missing in the EU. Upcoming Euro / Dollar War In the previous two years, US had scored a minor victory over the Euro by retaining all its advantages and preventing large-scale cash reserves transfer. This is a short-term victory. Europe, no matter how segmented and divided it is, will march ahead slowly nibbling at the Dollar’s prestige. Pointless wars in Middle East, huge trade deficit, emergence of China and India as economic power-houses, huge debt load are likely to affect the Dollar’s well being further. US is fully aware of it and would wish to exploit all the weaknesses of the Euro. This has become one of the main focus of the US treasury policy.  As a starter, US put the whole OPEC nations on the notice by completely discouraging any talk of using Euro as a reference currency. Last year when the Venezuela’s OPEC minister initiated a discussion on the subject, it incurred the wrath of USA. Now, reasons are emerging as to why US has been trashing the duly elected President of Venezuela. Then for similar reasons, a bit earlier, Saddam Hussein made himself a bigger target of US ire.  He partially traded his oil in Euro currency. For the OPEC nations switching to Euro make a better sense. Twenty years back US imported more oil than Europe. Today, the situation has reversed; it is the Euro zone, which imports more oil than US, hence using Euro as reference currency makes more sense. In these above two affairs, EU sat silently and allowed US to gain all the short-term advantages. But the long-term switching from Dollar to Euro is still in OPEC’s mind. They would rather not talk about it. The two rapidly emerging economies of China and India are kept in line with incentives and co-operation. China has a $500 Billion reserve and India has a $150 Billion reserve in the US currency. They both wish to diversify their holdings, possibly in Euro. US has some control over both the countries. China needs the FDI and market for its manufactured goods, hence cannot step out of line. India has bulk of its service sector exports and some FDI incoming from the US. India badly needs additional FDI and needs the service sector export market hence will tow the US line. In the foreseeable future they will be unable to diversify their cash holdings. When India talked about using part of its Dollar reserves to modernize its infrastructure, a firm no was the answer given by the US. Instead India was advised to seek FDI. Similar discussions have taken place in China. What Can Cause Dollar’s DownFall? No single factor can ever bring the dollar down. It will be a host of factors (some listed above) and others include, shear single-minded foolish US behavior of expensive outside wars, excessive manufacturing imports (from China & elsewhere), expensive life style at home and a huge trade deficit will ultimately so weaken the Dollar that alternatives will look attractive. Take for example the weak Dollar of today. It is caused mainly by the war expenditures in Iraq, economic impact of 9/11 terror strike, hurricanes Katrina & Rita and ever-growing trade deficit. It is causing pain in the OPEC countries. They lose money in lower oil revenues and reduced value of their cash reserves. They would rather keep their relationship with dollar a bit flexible and keep an alternative at hand, should the Dollar weaken further. That is where weak and fragmented Euro looks attractive. On a practical level there will be a cost involved in shift from Dollar to Euro.  Currency traders will incur additional hedging costs. The latter may offset advantages of the shift. Next ten to twenty years are a safe bet for the pre-eminent dominance of the Dollar. But a few more hard knocks to the US economy, a shift may be visible. Arrival of large money at EU’s doorstep may hasten the coalescing of the current fragmented state of the Europe. Hence consideration of Euro as a reference currency is a generation away. Weakening of the US dollar for a host of reasons will be the first step in that direction followed by Europe acting in one voice both politically and economically. Later China / India may play a significant role in currency re-orientation. These two rapidly developing economies of today (in a generation, developed countries) would not wish emergence of Europe as a colonial power one more time in the twenty first century. Memory of the eighteenth and nineteenth century world domination by Europe has been bad enough. Hence from their perspective, Dollar and Euro have to work together to establish a new respectable world monetary order. Should they fail then China / India could establish a new viable currency order backed by their huge economies and huge trade surpluses. (The author is a retired Vice President from C-I-L Inc. and has lived in   Canada  for the past 34 years. A graduate of  Punjab  University and  University of  Missouri ;   Rolla ,  USA , the author is a former investment strategies analyst and international relations manager. The Views expressed are his own. Email- harisud@hotmail.com)
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