EU Monitor 28
Reports on European integration
September 8, 2005
The euro: Well established as
a reserve currency
The euro is the world’s solid number two reserve currency, but well
behind the US dollar. The dollar share in global official, foreign exchange
reserve holdings declined to about 66% at the end of 2004. The euro has caught
up: its share rose from 17.9% in 1999 to about 25% in 2004.
The euro has the potential to challenge the dollar as a reserve
currency in light of the fact that Euroland has the world’s second largest
economy as well as large and liquid financial markets. The euro share in official
reserve holdings is expected to rise well beyond 25% given the increasing interest
of many central banks – especially in Asia – to diversify into euros. But the dollar
will remain the international reserve currency No. 1 in the years to come because
the US has some advantages which Euroland cannot offer. For instance, the US
economy has a better growth performance than Euroland and a more flexible
management of monetary and fiscal policy enabling it to react faster to economic
shocks.
Exchange rate policy is a strong motive to hold euro reserves. Roughly
50 countries with a euro peg or orientation hold euro reserves in order to be able
to intervene in the foreign exchange markets. The ten new EU member states are
a special case as they will only have to hold euro reserves until their EMU entry,
probably by the end of the decade. Moreover, the non-euro G7 countries – the US,
Japan, the UK and Canada – have to hold euro reserves so they can stick to their
G7 promise to ensure orderly market conditions by means of interventions.
Authors
Norbert Walter
+49 69 910-31810
norbert.walter@db.com
Werner Becker
+49 69 910-31713
werner.becker@db.com
Editor
Barbara Böttcher
The euro did not follow the long-term dollar rule that a weak exchange
rate automatically means losing ground as a reserve currency. Even when the
euro was weak between 1999 and 2001, its share as a reserve currency rose from
17.9% to almost 20%. One reason is that countries neighbouring the euro area
gave the euro a vote of confidence. The experience with the euro since 1999 is,
however, too short a period to ultimately assess the impact of the exchange rate
on euro reserve holding.
Official Foreign Exchange Reserves
Shares in %, end of year
60
50
Deutsche Bank Research
Frankfurt am Main
Germany
Internet: www.dbresearch.com
E-mail: marketing.dbr@db.com
Fax: +49 69 910-31877
Managing Director
Norbert Walter
70
Dollar
Technical Assistant
Martina Ebling
40
30
Euro
other countries
Yen
20
10
0
1999
2000
2001
2002
2003
2004
Source: IMF 2005
EU Monitor 28
2
September 8, 2005
The euro: well established as a reserve currency
Dominant dollar position
The dollar has been the key international trade, investment and
reserve currency for decades. Neither the D-mark nor the yen,
which gained some weight as international currencies in the 1970s
and 1980s, called the dominance of the dollar into question. But the
advent of the euro in 1999 brought the most dramatic change in the
international monetary system since the transition to flexible
exchange rates in the early seventies. It has been claimed –
surprisingly enough also by some American economists – that the
1
euro is likely to challenge the international position of the dollar in
view of the fact that the economic potential of the euro area is
similar to that of the US.
The euro: European answer
to globalisation
The introduction of the euro was the European answer to the
challenges of globalisation. It was primarily a political decision taken
to strengthen political cohesion among the members of the
European Economic and Monetary Union (EMU) and at the same
time promote the global role of Europe in monetary affairs and
beyond. But there are also valid economic arguments in favour of
EMU such as the elimination of intra-European foreign exchange
risks, the growth-stimulating convergence of interest rates and the
emergence of large and liquid euro financial markets.
Many questions concerning the euro’s
reserve currency role
This paper focuses on the development and the determinants of the
euro as an international reserve currency held by central banks or
monetary authorities. Therefore, it reviews the euro’s international
role in general and its status as a reserve currency in particular
since 1999. Many interesting questions arise: Which parameters will
determine the euro’s future role as reserve currency? How important
is the euro exchange rate in this context? Is the honeymoon of the
strong euro exchange rate already over with the currency having
peaked in January 2005 (at EUR 1.36/USD) and with the negative
referenda in France and the Netherlands in late May/early June
2005 pulling it down? What role will the euro have in a bipolar international monetary system alongside the dollar? What chance will
the euro have as a reserve currency of East Asian central banks?
ECB plays a neutral role
ECB monitors global use of the euro
The international use of a currency has some advantages for the
country that issues it. So far, the country that has benefited predominantly has been the US. For instance, international investors
enhance liquidity in financial markets and, more importantly, the
government benefits from seignorage. For its part, the ECB does not
actively promote the international role of the euro. Rather, the ECB
has explicitly declared that it pursues a neutral policy, i.e. it refrains
from hindering or promoting the international use of the euro. This is
true for all areas of international use including reserve holding by
central banks outside the euro area. However, the ECB regularly
monitors the international role of the euro and provides valuable
2
information about its global use.
Good euro performance in the international arena
Krugman matrix as yardstick
for international use
The euro’s international performance since 1999 can be illustrated
3
on the basis of the Krugman matrix which combines the three
classical functions of money – means of payment, unit of account
and store of value – with the international use of a currency by the
1
2
3
September 8, 2005
Robert Mundell (1998), The case for the euro – I and II, Wall Street Journal, March
24 and 25, A 22; C. Fred Bergsten (1997), The dollar and the euro, Foreign Affairs,
July/August, 83-95.
ECB (2005), Review of the international role of the euro.
P.R. Krugman (1997), Currencies and Crises, Cambridge (Mass.)
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EU Monitor 28
private and official sectors. The three private functions and the first
two official ones are also reviewed in order to find out whether they
are relevant for the euro’s reserve status.
Roles of an international
currency
Private
Official
use as
Medium of
exchange
Vehicle
Unit of account
Invoice
Peg
Store of value
Banking
Reserve
Intervention
Dollar dominant in trade
invoicing
Private-sector use of the euro as a medium of exchange can, for
instance, be shown by the foreign exchange turnover in the
euro/dollar market. The euro/dollar segment is the most intensively
traded currency pair and the euro is the second most actively traded
currency in foreign exchange markets worldwide (accounting for
4
37% of transactions compared with 89% in case of the dollar ). It is
much more important than the yen/dollar currency pair (20%) and
also more important than the D-mark/dollar pair was in April 1998
before the start of EMU (20%). Surprisingly, the average daily
turnover in the global foreign exchange markets rose to USD 1.9
trillion in April 2004 (at current exchange rates), a 57% increase
over April 2001 when the preceding survey was carried out. Driving
market forces have been investors’ growing interest in foreign
exchange as an asset class alternative to equity and fixed income,
the rising importance of hedge funds and the more active role of
asset managers – including the managers of foreign exchange
5
reserves of central banks.
As to invoicing of international trade transactions the dollar is still
dominant with a global market share of almost 50%. Moreover, oil
and other commodities are invoiced in dollars. But the euro has
more or less assumed a regional role in trade transactions. For
instance, euro invoicing in Euroland’s exports and imports of goods
and services has grown notably, reaching a share of over 50% in
many EMU member countries in 2003.
Good euro performance in
financial markets
The emergence of larger and more liquid euro financial markets has
been the most important event for international institutional investors
including reserve managers of central banks. There has been strong
use of the euro as an issuing currency in international bond markets
right from the start of EMU. The euro’s share in international bonds
issuance has fluctuated between 34% and 44% since 1999, i.e. it
has been close to the dollar (39% – 49%) but well ahead of the yen
(below 10%). The total stock of euro-denominated debt securities
reached a share of more than 30% at the end of 2003 compared
with about 20% in 1998 just before the start of EMU. The share of
the dollar decreased from about 48% to 44% during this period, and
that of the yen from 20% to about 10%.
The euro is a regional
anchor currency
As an intervention currency the euro has been used predominantly
by countries neighbouring the monetary union. About 50 small and
medium-sized countries in Europe, the Mediterranean and Africa
have pegged their currency to the euro or orient their exchange rate
policy towards the euro. Accordingly, they have accumulated euros
as reserve currency.
The euro has caught up as
reserve currency
As regards the proper role of the euro as reserve currency, it is not
surprising that the dollar is still the star in official foreign currency
reserve holdings of the world’s monetary authorities five years after
4
5
4
Bank for International Settlements (2004), Triennial Central Bank Survey of
Foreign Exchange and Derivatives Market Activity in April 2004. Because two
currencies are involved in each transaction, the sum of the percentage shares of
individual currencies totals 200% instead of 100%.
By contrast, there was a substantial fall in global trading volumes between 1998
and 2001 due to the introduction of the euro and global progress in the
consolidation of the banking industry.
September 8, 2005
The euro: well established as a reserve currency
6
the introduction of the euro. According to IMF statistics the dollar
share peaked at 71% in 1999 (year-end figure) but declined to about
66% at the end of 2003 and stayed there in 2004. By contrast, the
share of the euro rose from 17.9% in 1999 to about 25% in 2004.
This increase reflects the fact that the substantial appreciation vis-àvis the dollar since spring 2002 has improved the euro’s image in
financial markets and also in the eyes of asset managers of central
banks, in particular in Asia.
The dollar is still the key currency
All in all, the euro has been a success story in the international
arena since 1999. The international use of the euro as a trade,
investment, anchor and reserve currency has increased
considerably. The euro has even topped the international role of its
12 legacy currencies including the D-mark. Although the euro has
been catching up, it has as yet only come close to the dollar in a few
areas such as international bond issues. The dollar is still the key
currency and there is hardly any doubt about its remaining in the
driver’s seat in the foreseeable future. Therefore, media “rumours of
the death of the international role of the dollar are greatly
exaggerated”, to paraphrase the famous quote of Mark Twain.
What factors determine the use of the euro as a
reserve currency?
Determinants of a reserve currency
While the rising international use of the euro in the private sector is
the result of microeconomic decisions of yield-seeking market
participants, the official use as an intervention, anchor and reserve
currency is primarily based on macroeconomic or political
considerations. The future volume of official euro reserve holdings
by non-EMU central banks and monetary authorities in the world will
be determined – as a review of experience with the international use
of the euro since 1999 shows – by the anchor and intervention
functions of the euro, by the development of the euro exchange rate
as well as the liquidity of euro-based financial markets. What does
this mean in detail?
Euro-oriented exchange rate policy
The above-mentioned roughly 50 small and medium-sized countries
with a euro peg or a euro orientation for their currency need to hold
official euro reserves in order to boost confidence in their peg and/or
their exchange rate policy and to be able to intervene in the euro
foreign exchange market if necessary.
New member states a special case
The ten new EU member states that are obliged to join EMU once
they meet the Maastricht convergence criteria are a special case.
Meeting the exchange rate criterion requires a tension-free
participation in the European exchange rate mechanism (ERM) II for
at least two years. Estonia, Lithuania and Slovenia joined ERM II in
June 2004, and Cyprus, Latvia and Malta followed in May 2005.
Participation in ERM II is, however, conceived to be the “waiting
room” for entry into EMU. Some small countries – the three Baltic
members and Slovenia – are expected to introduce the euro at the
earliest date, in 2007. By contrast, the four bigger new EU member
6
September 8, 2005
The IMF Annual Report 2005 has considerably revised the data on identified
holdings on foreign reserves due to changes in the underlying database on the
Composition of Official Foreign Exchange Reserves (COFER). Both the dollar
and the euro share were reported to be between 2 to 6 percentage points higher
per annum in the period from 1999 to 2003 while the respective shares of the
yen, the pound sterling and unspecified currencies were much lower. The dollar
share peaked at 71% in 1999 compared with the message of the IMF Annual
Report 2004 that the dollar share peaked at 66.9% in 2001. The euro share
climbed from 17.9% in 1999 to a peak of 25.3% in 2003 whereas the IMF Annual
Report 2004 gave account of a rise of the euro share from 13.5% to 19.7% during
that period.
5
EU Monitor 28
states plan to join EMU only around the end of the decade. The
biggest hurdle on the road to EMU will be excessive budget deficits.
After EMU entry these countries will no longer have any need to
hold euro reserves as a policy tool.
G7 exchange rate cooperation
The non-euro G7 countries – the US, Japan, the UK and Canada –
basically need euro reserve holdings so they can stick to the G7
promise, repeatedly given by joint communiqués, “to monitor
exchange markets closely and cooperate as appropriate” in order to
ensure orderly market conditions. This cooperation includes joint
interventions in the foreign exchange market, for instance, by selling
euros to support the dollar. This implies that the US and the UK
should also hold official reserves in euros although both countries
are particularly reluctant to intervene in the foreign exchange
market.
Concerted G7 interventions cannot be
ruled out
In reality, the central banks of the G7 countries have not intervened
in the euro/dollar market since the joint action to support the weak
euro exchange rate in autumn 2000. But things have changed since
then. The euro exchange rate has risen considerably, on balance,
and a huge and unsustainable US current account deficit has
emerged causing increasing uncertainty for the dollar exchange
rate. Therefore, concerted international action aimed at establishing
orderly market conditions cannot be ruled out in the next few years.
Return-oriented investment strategy
Last but not least, a possible motive for virtually all non-EMU central
banks in the world to hold euro reserves could be to increase
returns on their national monetary wealth. For instance, one
investment strategy is to diversify in euros in order to reduce the risk
of over-concentration on the dollar. This is especially true for central
banks in East Asia with large dollar reserve holdings (see below).
How important is the exchange rate for use of the euro
as reserve currency?
Correlation between dollar exchange
rate and use as reserve currency
The long-term experience with the dollar as a reserve currency
shows that there is a long-term correlation between the development of the exchange rate and the dollar’s use as international
reserve currency. For instance, the weakness of the dollar exchange
rate in the 1970s has been associated with the rise of the D-mark
and the yen as alternative international reserve currencies at the
expense of the even then still dominant dollar. A further example is
the experience with the dollar and the D-mark or the euro since the
mid-1990s. The dollar’s share as a reserve currency rose from 59%
in 1995 to 71% in 1999 owing to a rising dollar exchange rate vis-àvis the D-mark – and later on vis-à-vis the euro – as well as sound
US fundamentals including buoyant growth.
The euro did not follow the
dollar correlation
But the euro did not follow the simple rule that a weak exchange
rate automatically means losing ground as a reserve currency. Even
when the euro was weak between 1999 and 2001, its share as a
reserve currency increased from 17.9% to almost 20%. Obviously,
neighbouring countries gave the euro a vote of confidence and
invested in it despite it lacking a direct track record.
Euro money and debt markets are
deemed to be as attractive as dollar
markets
But the international use of the euro as a reserve currency
continued to rise to about 25% in 2003 following the turnaround in
the euro/dollar exchange rate in spring 2002 and a substantial
7
appreciation of the euro. According to a recent central bank survey ,
7
6
The survey was carried out between September and December 2004 among 65
asset managers of central banks, see Robert Pringle and Nick Carver (2005),
Trends in reserve management – survey results, London, Central Banking
Publications.
September 8, 2005
The euro: well established as a reserve currency
the weaker dollar is a reason for many central banks to reduce the
dollar share of their official reserve holdings. It seems likely this
intention is not yet fully reflected in the end 2004 figure of a 24.9%
euro share.
The relatively short experience with the euro since 1999 has shown
that the correlation between the exchange rate and international use
as a reserve currency is less pronounced than one would think. The
reason is that the rankings of currencies in international use such as
the dollar and the euro tend to change quite slowly over time – on
the scale of years – whereas the exchange rate among them
8
changes rapidly – even within days .
Opportunity for the euro
It would, however, be too early to interpret the weakening of the
euro after the negative referenda in France and the Netherlands in
late May/early June 2005 as a starting signal for a reduction of the
euro’s share as an international reserve currency. Given the
increased uncertainty about future European integration and the still
lacklustre European growth performance, a weaker euro would not
be unjustified. Nevertheless, the dollar is expected to weaken due to
the excessive current account deficit, so the positive influence of the
exchange rate on the use of the euro as reserve currency should
basically remain intact.
Is there room for two leading reserve currencies?
The euro has potential to challenge
the dollar
The role of the euro in the international monetary system was
debated well before the start of EMU in 1999. Obviously, this issue
is again on the table in 2005. There is no simple answer to the
question whether the euro will be a serious challenge to the dollar in
terms of being an international currency including a reserve
currency. So far the answer has been that the dollar will remain
dominant. But there are indications that the euro has the capacity to
catch up further. The euro has the potential to challenge the dollar in
several areas of international use because the Euroland currency
9
fulfils two main preconditions .
Euroland is the second largest
economy
First, Euroland has the world’s second largest economy after the
US, well ahead of Japan. Although Euroland has a larger population
than the US it only produces the equivalent of 75% of US GDP at
current exchange rates. Euroland is the most important global
exporter, shipping about 13% of the world’s exports. But it absorbs
only about 12% of world imports, i.e. much less that the US with its
17% share reflecting the US role as a global growth engine.
Euroland produces about 21% of world GDP, compared with 27% in
the US. With a ratio of goods exports (extra-EMU) to GDP of about
13% Euroland’s degree of openness is higher than that of the US or
Japan.
Substantial progress in euro financial
market integration
Second, the introduction of the euro in 1999 was the catalyst for
pushing financial market integration in Euroland. Here, substantial
progress has been made in particular regarding the (interbank)
money market, which had been virtually fully integrated from day
one of EMU. There has also been substantial progress in euro bond
market integration. The liquidity of government bonds has risen
substantially, i.e. by governments focusing bond issues on a few –
8
9
September 8, 2005
Jeffrey A. Frenkel (2000), On the euro: the first 18 months, Deutsche Bank
Research, EMU Watch, Nr.87.
The euro will be to the dollar what Airbus Industries has become for Boeing, see
Norbert Walter (1998), Spitzenqualität, Der Euro wird für den Dollar, was Airbus
Industries für Boeing wurde, in: Maschinenmarkt, Das Industriemagazin,
Sonderausgabe.
7
EU Monitor 28
different – maturities. The high degree of liquidity in several national
government bond markets overcomes the disadvantage that there is
not a central government borrower in the euro area like the US
Treasury. Issuing activities have also flourished in the corporate and
mortgage bond markets. A salient feature was the introduction of
Euribor and Eonia as reference (interest) rates for financial market
operations including fixed income, futures and swaps.
FSAP is driving force
The integration process has been promoted by the ambitious
legislative programme of the Financial Services Action Plan (FSAP)
which was launched in 1999, essentially completed by mid-2004
and is now in the process of implementation. Money and debt
markets, which are very important for the diversification of central
banks into the euro, are working efficiently. But the financial markets
remain fragmented along the national border lines, for instance
10
regarding the equity markets and the retail banking markets .
There, different legal and tax systems are still major hurdles. But
those fragmented markets are not so important from the aspect of
the diversification of official foreign exchange reserves into euros.
The euro is a fully-fledged investment
alternative
By the same token, a recent survey among central banks has
concluded that the euro financial markets have reached the same
quality as dollar markets as far as the liquidity and the availability of
financial instruments in the money and debt markets are concerned.
Thus, if the quality of financial markets is no longer an argument for
choosing dollar assets, a major reason against diversification into
the euro is no longer valid from a central bank asset manager’s
point of view.
The euro has potential as reserve
currency
Against this background the euro is more or less a fully fledged
alternative to the dollar as a reserve currency. Thus the euro can,
and should, take more international responsibility in a bipolar
international monetary system. The euro has the potential to raise its
share well beyond the 25% posted for 2003 and 2004. In 2000,
Deutsche Bank Research estimated that the euro would be likely to
12
reach market shares of between 30 and 40% by 2010 . This is still
within reach with regard to the reserve currency status. It implies two
elements:
The dollar will remain No. 1 reserve
currency
Diversification into euros
11
— First, the dollar will remain the international reserve currency No.
1 in the years to come because the US has some advantages
which Euroland cannot offer. The US is a federal state and a
military superpower while Europe will remain in a politically
difficult situation for the time being since the French and Dutch
voted no in their referenda on the EU constitutional treaty.
Moreover, the US economy has a better growth performance
than Euroland and a more flexible macroeconomic management
regarding monetary and fiscal policy enabling it to react faster to
economic shocks.
— Second, an increasing role of the euro as reserve currency
implies that asset managers of non-EMU central banks –
especially in East Asia – must make decisions in favour of
diversifying and investing an increasing part of their foreign
exchange assets in euros.
10
11
12
8
Expert Group on Banking (2004), Financial Services Action Plan: Progress and
Prospects, Final Report.
See footnote 6.
Norbert Walter (2000), The Euro Second to (N)one, The American Institute for
Contemporary German Studies, German issues 23.
September 8, 2005
The euro: well established as a reserve currency
As things stand, the euro is the only serious candidate to challenge
the dollar in the international arena in the foreseeable future. Given
the importance of the dollar in Asia, the yen lacks the international
weight to become the third global pillar. The currency of the
emerging Asian giant China is still lacking the key preconditions – in
particular open, large and liquid financial markets – that would allow
it to play a role as an international reserve currency.
What will determine the asset management strategy of
East Asian central banks?
Asian central banks biggest reserve
holders
Central banks in East Asia are the biggest official reserve holders
investing predominantly in dollars. They have more than doubled
their currency reserves since the Asian crisis of 1997/98 and hold
almost 60% of global reserves of about USD 3.9 trillion at the end of
2004. The biggest Asian reserve holders are Japan (USD 823 bn),
China (USD 736 bn), Korea (USD 198 bn) and Taiwan (USD
13
242 bn) .
Currency composition of reserves
under review
Given the rising uncertainty surrounding the US current account
deficit and the dollar exchange rate it is compelling for central banks
with large dollar holdings to check the currency composition of their
reserves. One way to tackle the issue is to differentiate between two
types of accounts for official foreign exchange reserves:
Intervention account
On the one hand, an “intervention account” where funds must be
available at short notice in order to be able to intervene flexibly. This
account will be solely a policy tool and only focus on
macroeconomic targets.
Monetary wealth account
On the other hand, a “monetary wealth account” that will absorb the
remaining official foreign exchange reserves. Funds in this account
will be invested with the microeconomic aim of achieving an optimal
return on investment in order to enhance the national monetary
wealth.
Demand for higher performance
In the past, central banks were relatively conservative institutional
investors with a focus on (highly-rated) debt-denominated paper
(including medium and long-term maturities). They accepted lower
returns for less risk. Nevertheless, central banks did not ignore the
return aspect completely but put emphasis on an efficient portfolio
management including the use of arbitrage techniques and efficient
14
cash management . However, two events have triggered demand
for a higher performance from official reserves:
First, persistently low government bond yields have brought the
performance of central banks’ portfolios under pressure.
Substantial rise in reserves
New asset classes in
portfolio management
Second, global reserves have increased by a substantial 65%
during the past four years to the end of 2004, reaching a level – as
mentioned above – of about USD 3.9 trillion. Such high foreign
exchange reserves are definitely not needed for policy purposes.
Excess reserves are particularly suitable to be turned over to
professional asset management in order to enhance the return of
national monetary wealth and to transfer the profits to the shareholders – which are the finance ministers in most cases.
Obviously, many central banks around the globe stand ready to
invest in more risky asset classes including lower-rated bonds and
spread products in order to raise their yield, as the above-mentioned
13
14
September 8, 2005
Source: IMF; Central Bank of China (Taiwan)
John Francis Nugee (2005), Diversification in Central Bank Reserves
Management, State Street Global Advisors, Essays & Presentations, Fixed
Income.
9
EU Monitor 28
15
central banking survey has found out. Three-quarters of all central
banks interviewed conveyed the message that they have introduced
new asset classes in their portfolio management in the last 12 to 24
months. Unfortunately, there is hardly any information about
diversification into the euro on the part of Asian central banks.
Is there a way out of the dilemma for Asian central
banks?
Accumulation of large dollar reserves
East Asian central banks have accumulated huge dollar reserves in
recent years through interventions aiming to stabilise their exchange
rate vis-à-vis the dollar, thus supporting their exports. They invested
these sums to a very large extent in debt-denominated dollar assets,
thereby financing a substantial part of the US twin deficits in the
current account and the budget. For instance, East Asian central
banks increased their foreign exchange reserves by about USD 530
bn in 2004, thus financing about three-quarters of the huge US
current account deficit of 5.7% of GDP. This investment strategy has
also contributed to the relatively low level of US government bond
yields.
Idea of a revived Bretton Woods
System
There are different views on these US-Asian trade and currency
patterns. Some observers argue that there is a revived Bretton
16
Woods System and reserve accumulation will continue on the
basis of relatively stable exchange rates of Asian currencies vis-àvis the dollar. On the other hand it is argued that such a revived
Bretton Woods System is potentially unstable as the exchange rates
of Asian countries must also play a role in correcting the huge US
current account deficit. Thus, a noticeable appreciation of the
currencies of China and Japan (which have considerable bilateral
current account deficits with the US) is deemed to be appropriate.
The G7 has repeatedly conveyed the message to implement more
flexibility in exchange rates in Asia in recent years. However, more
exchange rate flexibility is now under way in East Asia after the
decision of China in July 2005 to suspend the dollar peg and to
move instead into a managed floating regime based on a basket of
17
currencies which takes account of major trading partners , foreign
debt flows and FDI. Nevertheless, China is still pursuing a cautious
approach in exchange rate policy. There was only a small
appreciation of the yuan against the dollar in the first few weeks (of
about 2%) in order to allow a smooth adjustment of the Chinese
foreign trade sector. Such a small step will hardly contribute to a
correction of the large US current account disequilibrium. A further
(gradual) appreciation of the yuan against the dollar is necessary
and expected.
China changes the exchange
rate regime
Impact on other Asian countries
The change in China’s exchange rate regime has repercussions on
exchange rate policies in the region. While Malaysia has also lifted
its dollar peg, most other East Asian countries are pursuing a
managed floating approach aimed at maintaining export competitiveness, i.e. avoiding a higher exchange rate against the yuan
and allowing only a moderate appreciation against the dollar. So far
only Korea has tolerated a noticeable appreciation against the
dollar, and Japan ceased interventions in the dollar/yen market in
April 2004 (though not causing any significant appreciation in the
yen).
15
16
17
10
See footnote 6.
Michael Dooley, David Folkerts-Landau, Peter Garber (2003), An Essay on a
Revived Bretton Woods System, Deutsche Bank, Global Market Research.
They include not only the US, Euroland, Japan and Korea but also Singapore, the
UK, Malaysia, Russia, Australia, Thailand and Canada.
September 8, 2005
The euro: well established as a reserve currency
Asset management dilemma
Given this background, Asian central banks are in an asset
management dilemma. On the one hand there are good arguments
for them to refrain from putting all their eggs in one basket and to
diversify at least a part of their reserves into euros. If the central
banks were to do so to a meaningful extent they would risk
triggering a noticeable depreciation of the dollar against the euro
and their local currencies. This would, however, also imply a
devaluation of their huge dollar reserves in terms of national
currencies. Therefore, the East Asian central banks have been
opposed to diversifying official reserves into euros. Obviously, there
is no easy way out of this dilemma.
Window of opportunity for the euro in
Asia
The upshot is that most Asian central banks are likely to continue to
accumulate foreign exchange reserves, albeit at a slower pace after
the change in the Chinese exchange rate regime. While the bulk of
business will still be in dollars, the euro has the chance to win a
somewhat bigger role in the important “Asian battlefield” and thus to
increase the euro’s role as a reserve currency.
Norbert Walter, (+49 69 910-31810 norbert.walter@db.com)
Werner Becker, (+49 69 910-31713 werner.becker@db.com)
September 8, 2005
11
EU Monitor
ISSN 1612-0272
Payments in Europe: Getting it right
Financial Market Special, No. 27 ........................................................................................................August 29, 2005
EU in crisis, Free trade, Direct Investment,
Eastern Europe’s textile and clothing industry
Reports on European integration, No. 26 .................................................................................................July 13, 2005
EU Savings Tax Directive is close to the finish line
Financial Market Special, No. 25 ............................................................................................................ May 19, 2005
Post-FSAP agenda: Window of opportunity
to complete financial market integration
Financial Market Special, No. 24 .............................................................................................................. May 6, 2005
Stability pact, Croatia, Integrated research policy
Reports on European integration, No. 23 ................................................................................................ April 28, 2005
Savings bank reform in France:
Plus ça change, plus ça reste – presque – le même
Financial Market Special, No. 22 .............................................................................................................. May 3, 2005
Fiscal policy, Chemical industry, Social policy
Reports on European integration, No. 21 .......................................................................................... January 14, 2005
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