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THE EURO AS AN INTERNATIONAL CURRENCY

The three basic functions of the euro

Every currency fulfils three functions: store of value, medium of exchange and unit of account. Concerning the first function (store of value), the euro is used and will increasingly be used as an investment and financing currency by market players, and as a reserve currency by public authorities. Regarding the second function of money (medium of exchange), the euro is used and will increasingly be used as a payment or vehicle currency for the exchange of goods and services and for currency exchange itself. It will also have an official use as an intervention currency.
Finally, as regards the third function of any currency (unit of account), the euro is used and will increasingly be used by economic agents as a pricing or quotation currency and as a pegging currency by the authorities responsible for exchange rate issues.

Let me give you some information about the present use of the euro in each of these areas. I shall first refer to the private use of the euro, after which I shall consider its official public usage.

The euro as a store of value

The available information seems to confirm that the euro already plays a significant role as an investment and financing currency in international financial markets. Without going into precise details (1), regarding the international debt securities market (money market instruments, bills and bonds), it can be said that in the first two quarters of 1999 net international issues denominated in euro amounted to
EUR 83.9 billion, compared with EUR 74 billion for the US dollar and EUR
50.9 billion for former euro area national currencies and ECUs during the same period of 1998. In other words, in the first two quarters of 1999 net international issues of debt securities denominated in euro were 13.4% higher than those denominated in US dollars, and 64.8% higher than those denominated in former euro area national currencies and ECUs issued during the same period of last year.

With regard to equity markets, the weight of euro area stock exchanges in terms of capitalisation ranks a clear second, far behind the
United States.

As to the banking sector, the latest data show that, at the end DX
:>48@>2:0 ?;5=:8T- -#"+ !-+ 1999DXCODE.HTof March 1999, above 40% of deposits and loans vis-а-vis non-residents were denominated in euro, with the share of the US dollar almost as high.

The euro as a medium of exchange

As for the second function of money (medium of exchange), the euro needs more time to develop as a payment currency for goods and services in international trade and as a vehicle currency in the foreign exchange markets. Although no precise data are available at this stage, the value of world exports denominated in euro is not likely to differ significantly from that of euro area exports. By contrast, the value of world exports settled in US dollars is nearly four times as high as that of US exports.
This difference can easily be explained by the combined and reinforcing effects of network externalities and economies of scale in the use of a predominant international currency, as is the case with the US dollar.

The euro as a unit of account

The use of the euro as a unit of account (its third general function) is closely linked to its use for the other two main functions. The use of a currency as a unit of account is, in a way, the basis for its use as a store of value or as a medium of exchange. The value stored in euro, or the payments made in euro, will tend to be recorded in euro. Therefore, we can conclude that the euro is playing an ever larger role as a unit of account for all the financial assets linked to the use of the euro as an investment and financing currency, and has a much less relevant role as a standard for pricing goods and services, owing to the widespread use of the US dollar as a payment and vehicle currency in international trade. The convenience of using a single standard for pricing commodities in the international markets, allowing traders to make direct comparisons between prices, makes it difficult for the euro to acquire a significant role in this respect. We can conclude that the development of the euro as a unit of account will follow the pace at which the issuers or suppliers of assets, goods or services priced or quoted in euro obtain a predominant position in the international markets.

The official use of the euro

The euro also has official uses as reserve, intervention and pegging currency, all three functions being strongly interrelated in most cases.

With regard to its official use, the euro is currently the second most international currency after the US dollar, this being a legacy of the former euro area national currencies.

Compared with the former euro area national currencies, there has been a technical decline in the share of the euro as a reserve (and, therefore, as an intervention) currency, mainly owing to the fact that such former national currencies became domestic assets within the euro area.
However, there are good reasons to expect an increase in international public use of the euro as a reserve and intervention currency, inasmuch as the public authorities understand that it is worthwhile to allocate their foreign reserves among the main international currencies and to give the euro a relevant share in accordance with its internal and external stability and the economic and financial importance of the euro area.

In connection with the use of the euro as a pegging currency, approximately 30 countries outside the euro area currently have exchange rate regimes involving the euro to a greater or lesser extent. These exchange rate regimes are: currency boards (Bosnia-Herzegovina, Bulgaria,
Estonia); currencies pegged to the euro (Cyprus, FYROM [the Former Yugoslav
Republic of Macedonia] and 14 African countries in which the CFA franc is the legal tender); currencies pegged to a basket of currencies including the euro, in some cases with a fluctuation band (Hungary, Iceland, Poland,
Turkey, etc.); systems of managed floating in which the euro is used informally as the reference currency (Czech Republic, Slovak Republic and
Slovenia); and, last but not least, European Union currencies pegged to the euro through a co-operative arrangement, namely ERM II. As you well know,
Denmark and Greece joined ERM II on 1 January 1999 with a ±2.25% fluctuation band for the Danish krone and a ±15% fluctuation band for the
Greek drachma. Although the euro remains in second position after the US dollar in terms of its official use, the role of the euro will increase in the future, without a doubt.

The position of the Eurosystem concerning the international role of the euro

As a general conclusion stemming from the previous analysis of the use of the euro in the world economy, we can affirm that the euro is the second most widely used currency, behind the US dollar and ahead of the
Japanese yen. The private use of the euro as an investment and financing currency and its official use as a reserve, intervention and pegging currency are increasing rapidly, while it is developing at a slower pace as a payment currency in the exchange of goods and services. The use of the euro as a unit of account is linked to its use as store of value and a medium of exchange.

Taking the current situation as a starting point, the Eurosystem's position concerning the future international role of the euro is crystal clear: we shall not adopt a belligerent stance in order to force the use of the euro upon the world economy. We are convinced that the use of the euro as an international currency will come about anyway. It will happen spontaneously, slowly but inexorably, without any impulses other than those based on free will and the decisions of market participants, without any logic other than that of the market. In other words, the internationalisation of the euro is not a policy objective of the
Eurosystem; it will neither be fostered nor hindered by us. The development of the euro as an international currency will be a market-driven process, a free process, which will take place, without a doubt.

Factors determining the importance of the euro in the world economy

We understand that the euro fulfils the necessary conditions to become a leading international currency with the US dollar and not against it. There is enough room for both currencies in the world economy.

The necessary conditions for a currency to become an international currency are based on two broad factors: low risk and large size. The low risk factor is related to the confidence inspired by the currency and its central bank, which in turn mainly depends on the internal and external stability of the currency. The low risk factor tends to lead to diversification among international currencies, since diversification is a means to reduce the overall risk; it acts, so to speak, as a centrifugal force. By contrast, the large size factor relates to the relative demographic economic and financial importance of the area which supports the currency; in other words, the "habitat" of the currency. The large size factor generally tends to lead to centralisation around one or several key international currencies. It can be seen as a centripetal force, as a virtuous circle, which will tend to lead to an increasing use of the euro as an international currency. Let us consider these two factors in more detail.

The stability of the currency and the credibility of the ECB

The first factor concerns low risk, credibility and stability. The stability of the euro is a priority for the ECB. Compared with the idea of stability, the strength of the euro is of lesser importance. This does not mean that the exchange rate of the euro does not constitute an element to be considered in the monetary policy strategy of the ECB. However, the basic factor that will determine the importance of the euro as a widely used currency in the world economy, in addition to the demographic, economic and financial dimensions of the euro area, is, without a doubt, the stability of the new currency, understood as a means to maintain the purchasing power of savings.

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