The following was originally published by the European Institute, and can be found at http://www.europeaninstitute.org/EA‐February‐2014/the‐euro‐at‐age‐15‐is‐it‐a‐reserve‐currency‐ yet.html. It is posted here with permission of the author. The Euro at Age 15 — Is it a Reserve Currency Yet? By J. Paul Horne, Independent International Market Economist
The euro was welcomed at birth on Jan. 1, 1999, as a new financial currency (coins and banknotes were issued three years later) and hoped by its promoters to be an alternative to the dollar, which had reigned as the world’s primary reserve currency since the 1944 Bretton Woods agreement. In its early years, the share of global official foreign exchange reserves denominated in EUR rose rapidly, while those in USD declined. But the Euro-zone debt crisis threatened, from late 2009, the euro’s very existence, making any speculation that it might replace the dollar as the world’s principal reserve currency seem a bad joke. The existential threat to the currency and even the European Union (EU), forced Euro-zone governments, the European Central Bank and the banking system to forge a more credible governmental, financial and regulatory structure to support the euro. [1] Protected by the ECB’s pledge to do ”whatever it took” to defend the euro, peripheral Euro governments endured austerity and debt reduction programs which enabled Ireland, Portugal, Spain and even Greece to make significant progress and gain credibility with markets. Their government bond yield spreads over the benchmark German bund yield (the best indicator of debt stresses) have dropped sharply from crisis highs. Euro equity and bond markets rose in 2012 (when Greek government bonds were among the best performing financial assets) and in 2013. Forex markets treated the euro with growing respect after it hit a crisis low of only $1.19 in June 2010. In fact, the USD:EUR rate has averaged a solid $1.33 since late 2009 (and $1.22 since the euro’s inception). The improvement of these key financial indicators reflects the Euro-zone’s notable structural and governance reforms . (See Footnote 1.) On its 15th birthday, perhaps it is time to consider whether the euro is, or can remain, a viable reserve currency. But first, what is a reserve currency ? First, it must be a currency important and credible enough to be used widely for international trade and capital transactions between countries other than the one issuing the currency. Second, the currency must be supported by a large and stable economy; and a government whose fiscal and monetary policies inspire the confidence of international traders and investors. Third, the currency’s exchange value must be relatively stable and predictable enough so that the world’s central banks are willing to accumulate and hold the currency in their official foreign exchange reserves. Finally, a reserve currency must be regarded as a “store of value,” usually measured by its purchasing power in terms of the holder’s own currency. If it is not, central banks and other international investors will not hold that currency for a significant time and it will not be a reserve currency. In 1944, the Bretton Woods agreement