Since the launch of the euro, much attention has been focused on the international role it might play. Seen from the outside, a single European currency should have become a rival to the dollar. From the inside, though, the notion of the euro becoming a major reserve currency was not a stated European objective. Market forces would be left to decide its fate.
Two decades on, however, the world feels under pressure to take sides in the growing strategic competition between China and the United States. The European Union is waking up to the reality of a stuttering Transatlantic Alliance and an increasingly assertive China. Among the tools the EU has to protect, and possibly regain some of, its lost economic sovereignty, fostering the euro´s role as an international currency is one of the most obvious. Interestingly, at the current juncture, it is not only the EU that needs the euro to support its strategic autonomy. So does the rest of the world, particularly China and any country that fears US weaponisation of the dollar. This also means that economic fundamentals might not the key factor behind the push for greater international use of the euro. Geopolitics seems to be taking the front seat.
The euro is already the second most internationally-traded currency after the dollar, but it still lags in terms of some of the key functions of an international currency, such as serving as a reference for private and official use. Commodity markets and other currencies outside the euro area do not choose the euro as a reference to set their prices. Furthermore, the euro’s international role took a big hit during the European sovereign debt crisis a decade ago, when the single currency’s survival was at risk and euro-denominated cross-border settlements fell substantially. One could argue that this was a reflection of market forces: the incumbent´s advantage and, especially, the euro area’s smaller share of the global economy. Furthermore, the US is a massive net international debtor, with non-residents holding a huge pool of liquid financial assets. This is certainly not the case for the euro area, which is still a net external creditor and has fragmented capital markets.
Beyond economic factors, the euro has also lacked the political support to become a more entrenched reserve currency, something that became very evident during the euro-area sovereign debt crisis. But things have changed. The erosion of the so-called liberal economic order, the increasingly hostile external environment and the fear that EU countries might take different sides in the China-US competition, have alerted the bloc’s leaders to the urgent need to boost economic (and technological) sovereignty. The euro is one of the remaining reliable foundations to build upon. This means that having an international currency is no longer a risk to price stability, as the European Central Bank might have thought at the time of the euro’s inception, but rather an opportunity to exert economic power beyond borders.
The question is whether actions are being taken in line with the domestic and external needs for the euro to acquire a greater international role. The answer is yes on both fronts. Internally, the ECB is reacting much more aggressively to the COVID-19 pandemic than it did during the European sovereign debt crisis, by providing temporary unlimited liquidity and a backstop to public debt. Furthermore, it has also extended swap lines to a number of central banks outside the euro area, following the Fed’s example. In addition, an EU-level risk-free asset is about to be created for the financing of the EU’s €750 billion recovery fund. Externally, China and Russia have been diversifying away from the US dollar, when one looks at their holdings of US government paper and dollar assets in their reserves.
It goes without saying that more steps are needed to boost the euro as an international currency, but more economic steps might not offer the full answer. A more united foreign policy seems to be the crucial factor that would further push for economic – and other forms of – sovereignty.
All in all, the time might have arrived for a more internationalised euro, because of the EU’s quest for strategic autonomy, and because of the need for China and other emerging countries threatened by the US weaponisation of the dollar, to find an alternative currency to trade with. The euro, an orphan currency at its inception, can thus find more backing now than could previously have been imagined. It is all about lack of options, internally and externally.