The euro's rise as an international exchange and reserve currency is being slowed by the incoherence of European monetary and fiscal policy, said economist Barry Eichengreen in an interview with EURACTIV.
Barry Eichengreen is professor of economics and political science at the University of California, Berkeley. He is the author of numerous books including 'Golden Fetters: The Gold Standard and the Depression' and most recently 'Exorbitant Privilege: The Rise and Fall of the Dollar'.
He was speaking to EURACTIV's Craig Willy.
The World Bank published last May a report predicting that a 'tripolar' financial system including the yuan and euro would exist by 2025. You have made similar predictions. Why do you think the dollar's current preeminent position is not sustainable?
For two reasons. First, the United States no longer dominates the world economy to the same extent as before. After World War II, there was no rival to the US as the dominant economy. The US was the leading exporter and leading industrial power.
Today, obviously, the US has economic rivals like Europe and China. With the US accounting for only 20% of the world economy, it is no longer obvious that the dollar should be involved in 85% of all foreign exchange transactions or account for more than 60% of foreign exchange reserves.
Second, the technology of international finance is changing. Once it was costly to engage in international transactions using a different currency than the one utilised by everyone else. Interchangeability costs were high.
Now the costs of comparing prices in different currencies has come down courtesy of smartphones and the Internet. The costs of changing money have come down courtesy of the same electronic platforms. Where two decades ago, technology left room for only one dominant international currency, today's technologies make it easy for multiple international currencies to coexist.
You entitled your most recent book on the dollar Exorbitant Privilege, what benefits does the United States draw from having the world's primary currency for reserves and foreign exchange transactions?
It is convenient for US banks and firms to conduct cross-border business in their own currency. Not having to hedge exchange risk lowers their costs and enhances their competitiveness.
The US government for its part can fund its public debt more cheaply insofar as there is a demand on the part of foreign central banks and governments to hold its government bonds as international reserves.
The US can run modestly larger current account deficits than otherwise, and American consumers correspondingly enjoy modestly higher living standards. I add all this up, and I conclude that US living standards are 1-2% higher than they would be otherwise.
As a follow up, what benefits would there be for the euro zone and China if their currencies were to eventually rival the dollar?
The euro zone and China would share in all the aforementioned benefits. Chinese policymakers' desire to internationalise the yuan, for example, reflects the recognition that enabling Chinese firms and banks to do more of their cross-border business in yuan would be a convenience and enhance their competitiveness.
The EU and the US have taken strikingly opposed responses to the financial crisis: the US deficit in 2010 (9%) was half again more than the eurozone average (6%) and the Fed's main interest rate is at 0%, while the comparable figure for the euro zone was increased to 1.5% by the European Central Bank last July. Why is this?
Europe has moved faster in the direction of fiscal consolidation partly because of economics: countries like Greece, Ireland and now Italy, with heavier debts than the United States, essentially had no choice.
But it has moved faster partly because of politics: there is a political phobia of budget deficits because there is a political phobia of inflation. Anyway, fully understanding the different policy responses requires much more time than we have here.
Why are the ECB's policy rates so much higher than the Fed's?
That one is easy to answer: because the ECB made a mistake. Specifically, it overestimated the vigour of the recovery and underestimated the danger of a double dip.
There are very strong critics of both the more austere and the Keynesian approaches. Which do you think is the better strategy in the current situation?
Stimulus now, austerity later. It is hard to imagine how a clear-eyed observer of current circumstances could see a different answer. I guess the implication is that too many policymakers have failing vision.
Notwithstanding the current eurozone crisis, the ECB has been very successful in its 'hard currency' approach, some would say too much so. One euro today is valued at 1.37 dollars or 0.86 pounds. Americans complain that the yuan's undervaluation relative to the dollar is hurting their exports. Might Europeans have even stronger grounds to complain to the ECB on this issue?
From my earlier remarks about the ECB's policy rate, you can undoubtedly infer my answer. Europe would have been better served by a more accommodating policy, given how inflationary pressures earlier this year were largely transitory and the recovery is now stalling out.
A somewhat weaker currency would have flowed from that policy, and that might have helped to sustain the recovery. But hindsight, to stick with the metaphor, is 20/20.
Why does the euro zone appear so unable to resolve its sovereign debt crisis? Though the use of the euro as a reserve currency and in foreign transactions has risen since 1999, does this not detract from predictions of its rise and the decline of the dollar?
The inability of European policymakers to resolve their crisis and the questions now being asked about the future of the euro certainly limit its attractions as an international currency. The incoherence of the European policy response is the main thing working in favour of the dollar's continued international role.
Why have European policymakers been unable to take decisive action to resolve its sovereign debt crisis? Answering that question would require a book. And no doubt there will be books.
But if you want my answer in a nutshell, this would be: Europe's crisis is more than just a sovereign debt crisis. It is a banking crisis. It is also a political crisis. And it is also a social crisis.