Internationalization

of Currencies: The Case

of the US Dollar and
Its Challenger Euro
George S. Tavlas
This article examines the benefits and costs to the United States
of having the US dollar used as an international currency and
explains the factors underlying the dollar's use internationally.
The main benefit for the United States is that it derives
seigniorage from the dollar's international use while the main
cost is that there is less scope for controlling domestic monetary
conditions. There are three prerequisites for the international
use of a currency: (1) confidence in the political stability of the
issuing country; (2) deep, broad, and open financial markets in
the issuing country; and (3) a large share of world exports on the
part of the issuing country. The implications of the euro for the
dollar's leading international position are discussed. Data are
presented showing that the dollar is the world's leading
international currency. 1997 John Wiley & Sons, Inc.
INTRODUCTION
The US dollar is the world's most widely used currency, having
played this role for over half a century. In Eastern Europe or Latin
I am grateful to Taeho Kim for very helpful comments on an earlier draft. The views expressed
are the author's own and should not be interpreted as those of the Bank of Greece or the
International Monetary Fund.
George S. Tavlas is with the Bank of Greeceand the International Monetary Fund.
The International Executive, Vol. 39(5) 581-597 (September/October 1997)
1997 John Wiley & Sons, Inc. CCC 0020-6652/97/050581-17
581
582 TAVLAS
American countries that have experienced high inflation rates in the
recent past, prices are often quoted in dollars and many transactions
are settled in dollars. The prices of primary products, such as oil,
grains, and metals, and of capital assets are typically denominated
worldwide in dollars, and trade in these products is usually con-
ducted with US currency. So widespread is the use of the dollar out-
side of the borders of the United States that it is estimated that over
50 percent of world trade is settled in dollars (Tavlas, 1991).
A main function of money is to serve as a unit of account, or com-
mon denominator, against which the prices of all other goods and
services can be compared. By using money, individuals reduce the
amount of information that they must acquire, process, or store in
order to transact business. Without money, multiple calculations and
lengthy transactions chains would be required to exchange the good
or service desired for the good and service offered. Just as a nation-
al money reduces the costs of calculation and transacting domesti-
cally, so the use of a single international currency reduces these costs
worldwide. Thus, as the world's main international currency, the dol-
lar plays the vital role of transmitting information about relative
prices in the global economy, similar to the role played by a nation-
al money in the context of a domestic economy.
Because money transmits information about relative prices, the
use of a single money worldwide performs a similar function as does
the use of an international language. The use of both a single inter-
national language and a single international money facilitate com-
munication. The use of a language by just one person is of no social
value. The greater the number of people who speak a language, the
more that language can facilitate communication. The same is true
of money. A currency hardly functions as a useful unit of account,
medium of exchange, and store of value, if only a single person uses
it. The utility of money depends, in part, on how many others use it.
When a Saudi Arabian exporter, who does not speak Italian, sells
crude oil to an Italian importer, who does not speak Arabic, commu-
nication is likely to be conducted in English. Similarly, the price of
oil and settlement of the transaction are likely to be in dollars. Thus,
the use of the dollar in the transaction, as the use of the English lan-
guage, leads to economies of communication in transmitting infor-
mation. As English is the lingua franca of international discourse, so
the dollar is the lingua franca of international monetary arrange-
ments.
This article examines the benefits and costs to the United States
of having its currency used internationally and explains the factors
underlying the dollar's use as an international currency. It presents
recent data regarding the dollar's international use. European mon-
INTERNATIONALIZATION OF CURRENCIES 583
etary union (EMU) and the adoption of the euro as a single curren-
cy within EMU are expected to pose a strong challenge to the dol-
lar's role as an international currency in the future. The implications
of the euro for the dollar are, therefore, discussed.
THE FUNCTIONS OF INTERNATIONAL MONEY
An international currency fulfills three basic functions in the inter-
national monetary system (Krugman, 1984). It serves as a medium
of exchange, a unit of account, and a store of value. As a medium of
exchange, it is used by private agents both in direct exchange and
as a vehicle of indirect exchange between two other currencies in
foreign trade and international capital transactions. It is also used
by official agents as a vehicle for intervention and for balance-
of-payments financing. As a unit of account, it is used to invoice mer-
chandise trade, to denominate financial transactions, and, by official
agents, to define exchange-rate parities. As a store of value, it is
used by private agents when choosing financial assets, such as bondj
held by nonresidents. Similarly, official agents may hold an interna-
tional currency and financial assets denominated in it as reserve as-
sets.
A national currency can be utilized outside the borders of the na-
tion that issued it in two contexts. First, a currency can be used to
denominate and/or execute foreign trade and international capital
transactions between agents of different countries. For example, if
US exports to Japan are denominated, and paid for, in US dollars,
the dollar is used as an international currency. A currency can also
be used as a vehicle to denominate and/or effect international trans-
actions to which the issuing country is not a party; thus, if Saudi
Arabia exports to Italy are denominated, and paid for, in US dollars,
the dollar is used as a vehicle. A currency is used as a vehicle when
the transactions costs, including the costs of information, search, un-
certainty, and enforcement, are lower through the vehicle than
through other nonvehicle currencies. Once a currency emerges as a
vehicle, economies of scale enter into play, further decreasing trans-
actions costs and enhancing the currency's position as a vehicle. Sec-
ond, agents within any country can use another country's currency
to denominate and/or execute domestic transactions. This use of a
foreign country's currency in domestic transactions is typically re-
ferred to as a currency substitution (Cohen, 1995: 8). Both types of
transaction-i.e., those between agents of different countries and
those between agents of the same country-represent the interna-
tional use of a currency.
584 TAVLAS
CostslBenefits of the International Currency
to the Issuing Country
International currency use provides several major benefits to the is-
suing country. First, the country derives seigniorage because the
non-interest bearing claims built on it are denominated in its own
currency. That is, the issuing country does not pay interest to hold-
ers of its currency, but it can use its currency to purchase interest
bearing assets. Blinder (1995: 12) estimates that this seigniorage
revenue for the United States amounts to between $11 billion and
$15 billion per year. In this connection, the Federal Reserve Board
estimates that 50-60 percent of US currency is held outside the bor-
ders ofthe United States (Blinder, 1995: 6). Additionally, because the
nominal interest rate on debt is comprised of a real component and
an expected-inflation component, a country with an international
currency can create extra seigniorage by unexpectedly inflating its
currency (although doing so would jeopardize the international use
of its currency) (Bailey, 1956). Second, as the international use of a
currency expands, loans, investments, and purchases of goods and
services will increasingly be executed through the financial institu-
tions of the issuing country. Thus, the earnings of its financial sec-
tor are likely to increase (Cohen, 1971: 37). Third, invoicing in an in-
ternational currency can help shield the issuing country from
exchange rate changes. For example, if the dollar declines in value
against other currencies, the prices of primary products, which are
mostly denominated in dollars, typically do not rise. Consequently,
"dollar invoicing may help explain the relative immunity of US do-
mestic prices from exchange rate influences" (Blinder, 1985: 13). Fi-
nally, US corporations that export and import products denominat-
ed in dollars receive the benefit in that their transactions are not
subject to exchange rate risk.
The main cost of having a currency used internationally is the
large stock of a country's liabilities held by foreigners implies that
there is less scope for controlling domestic monetary conditions. Un-
der pegged exchange rates, a shift in preferences by foreigners can
lead to large capital flows and undermine the capacity of the mone-
tary authorities to control the monetary base and influence do-
mestic economic activity. Under floating rates, such a shift can lead
to large variations in the exchange rate, which could also limit
the degree of influence exerted by the authorities over the domestic
economy.
Determinants of International Currency Use
There are three prerequisites for the international use of a nation's
currency (Tavlas, 1991; Tavlas and Ozeki, 1992): (1) confidence in
INTERNATIONALIZATION OF CURRENCIES 585
both the political stability of the issuing country and in the value of
its currency; (2) deep, broad, and open financial markets in the is-
suing country; and (3) a large share of world exports on the part of
the issuing country and a large absolute value of exports of differ-
entiated manufactured products.
Inflation and Inflation Variability
With regard to confidence in the value of a currency, high and vari-
able inflation rates-relative to those of other countries-generate
nominal exchange rate depreciation and uncertainty. In order to
serve as an international unit of account (as well as a means of pay-
ment and store of value), a currency should be stable in value so that
its price relative to other currencies provides sufficient information
to make it generally accessible to market participants, making it un-
necessary for them to undertake costly investigation. High and vari-
able inflation rates in the country whose currency is used interna-
tionally increase the costs of acquiring information and performing
efficient calculations of the prices bid and asked for goods, services,
and capital assets. Transactors, therefore, face a signal extraction
problem in that they have less scope to decompose unexpected price
variations into changes attributable to changes in demand or supply
in world markets, and those attributable to inflation variability in
the country whose currency is being used as an international nu-
meraire (Lucas, 1973).
Table 1 reports data on inflation and inflation variability (as mea-
sured by the standard deviations of national inflation rates) from
1970 to 1995 and for various subperiods for the United States,
France, Germany, Japan, Switzerland, and the United Kingdom. In
terms of inflation performance, the United States scores in the mid-
dle of the countries included in the table. For example, for the peri-
od as a whole, the United States registered the fourth lowest infla-
tion rate (at 5.7 percent). Over the subperiods 1985-1989 and
1990-1995, the United States again registered the fourth lowest in-
flation rates, at 3.6 percent and 3.5 percent, respectively. Similar re-
sults pertain to other subperiods and to inflation variability. These
data indicate that the United States has had a relatively high infla-
tion rate over the period considered, and that other factors account
for the dollar's leading international position.
Financial Markets
A country whose currency is used internationally should possess fi-
nancial markets that are broad (i.e., with a large assortment of fi-
nancial instruments traded), deep (i.e., including well-developed sec-
586 TAVLAS
Table 1. Inflation and Inflation Variability (In Percent)
United Switzer- United
Period States France Gennany Japan land Kingdom
Average inflation rate
1970-74 6.1 7.7 5.6 10.7 7.1 9.6
1975-79 8.1 10.1 4.1 7.5 2.9 15.7
1980-84 7.5 11.2 4.5 3.9 4.4 9.6
1985-89 3.6 3.6 1.3 1.1 2.1 5.3
1990-95 3.5 2.5 3.2 1.7 3.5 4.4
1970-82 7.8 9.8 5.1 8.2 5.1 12.7
1983-95 3.6 3.8 2.4 1.5 2.9 4.8
1970-95 5.7 6.8 3.7 4.9 4.0 8.7
Inflation variability!
1970-74 2.8 3.1 1.4 6.8 2.3 3.6
1975-79 2.2 1.2 1.2 3.3 2.4 5.8
1980-84 3.9 2.4 1.5 2.2 1.6 5.2
1985-89 1.1 1.3 1.2 1.0 1.1 1.7
1990-95 1.1 0.7 0.9 1.2 1.8 2.7
1970-82 3.1 3.0 1.4 5.3 2.8 5.4
1983-95 1.0 2.3 1.3 1.1 1.6 2.2
1970-95
2
3.1 4.0 1.9 5.1 2.5 5.7
1Based on cunsumer price indices; variability measured by standard deviation using quarterly data for
indicated periods.
2The average of the sum of the standard deviations does not necessarily equal the average standard de-
viation for the entire period.
Source: IMF, International Financial Statistics.
ondary markets), and substantially free of controls (such as trade re-
strictions and capital controls). As Williams (1968: 169) and McKin-
non (1979: 77-78) have pointed out, the dominance of sterling in in-
ternational trade during the second half of the nineteenth century
reflected in part the fact that London was a financial center in which
trade bills from the rest of the world were discounted at relatively
low rates of interest. Correspondingly, active short-term (e.g., trea-
sury bill and commercial paper) markets in a country contribute to
the international demand for its currency, reflecting central banks'
and other investors' preferences for liquid and safe financial instru-
ments. The strong presence of foreign financial firms in a country's
domestic market also contributes to the international use of its cur-
rency, in that it stimulates foreign investment in domestic securities.
The United States has long been a dominant international finan-
cial center. In this connection, a recent study by Smith (1992) ana-
lyzed changes in shares of selected international financial markets
INTERNATIONALIZATION OF CURRENCIES 587
among major industrial countries during 1980-1989. The countries
analyzed were: Australia, Belgium, Canada, France, Germany, Italy,
Japan, the Netherlands, Switzerland, the United Kingdom, the Unit-
ed States, and the Nordic group. The following markets were in-
cluded in his study: foreign exchange, mergers and acquisition ad-
vice, syndicated bank loans, Eurobond, international equities,
Euro-commercial paper, and Euro-medium-term notes. Smith (1992:
69-70) found that: "The salient feature of recent developments in
these selected financial markets is the extent to which they have
been dominated by American financial institutions. With hardly any
qualification, the United States obtained the largest shares of these
markets at both the beginning and end of the period in question, and
its share has been greater than 50 percent." He also found, howev-
er, that there was a tendency for US market shares to decline dur-
ing the sample period.
Smith attributed the superior performance of US financial mar-
kets to such factors as the quality of human resources employed in
financial services in the United States, an innovative system that is
relatively free of controls and allows US firms to respond quickly to
clients' needs, and economies of scale in providing financial services
(Smith, 1992: 157-160). Table 2 presents data on the size of domes-
tic financial markets in the United States and the other Big Seven
industrial countries. A striking aspect of these data is the extent of
the dominance of US financial markets. In terms of domestic debt
outstanding, the US capital market is larger than the combined to-
tal of the other six capital markets (as of March 1996). With regard
to stock market capitalization, the US stock market is almost as
large as the combined total of the other six share markets.
Volume and Composition of Trade
The third factor influencing the international use of a currency is the
size of its foreign trade and the magnitude of its exports of manu-
factured products. With regard to the size of trade, the larger a coun-
try's trade, the more likely are agents in other countries to be fa-
miliar with its currency and probable movements in the currency
(Bailey and Tavlas, 1988). As Page (1981, p. 62) has observed, "such
a currency is also likely to offer a strong forward market. Both fa-
miliarity and the facility to reduce risk encourage its use." With re-
spect to the composition of its trade, studies of invoicing behavior
(e.g., Grassman, 1973; Scharrer, 1980; Page, 1981) have shown that:
(1) trade between developed countries in manufactured products is
likely to be invoiced in the currency of the exporter; and (2) invoic-
ing in the exporter's currency occurs more frequently for differenti-
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INTERNATIONALIZATION OF CURRENCIES 589
ated manufactured products with long production lags. However,
some countries with a large share of exports consisting of manufac-
tured products have discouraged the international use of their cur-
rencies. Thus, their exports may not be denominated in the domes-
tic currency even if a large share of such exports are comprised of
manufactured goods. This has been the situation in the case of Japan
(Tavlas and Ozeki, 1992).
These observed invoicing patterns are explained as follows. When-
ever an importer or an exporter invoices in a foreign currency, the
revenues or costs (in terms of domestic currency) of the importer or
exporter will be affected if the exchange rate changes. Consequent-
ly, both the exporter and the importer prefer to invoice in their home
currencies in order to minimize foreign exchange risk. Traders can,
of course, use the forward market to cover their risks, but, as stud-
ies of invoicing behavior have shown, importers have not generally
hedged their foreign exchange exposures in forward markets or cur-
rency-futures markets. Such markets are typically thinner than spot
markets and, therefore, entail larger bid-ask spreads.
Ifboth exporters and importers prefer to invoice in their home cur-
rencies the issue arises as to why trade in differentiated manufac-
tured products is likely to be invoiced in the currency of the exporter.
When making the invoicing decision, both the exporter and the im-
porter attempt to minimize the variance of their total profits. This
variance is a measure of risk and depends importantly on the co-
variance between revenues and costs. The variance of profits is de-
fined as:
Var(P) = Var(R) + Var(C) - 2Cov(R,C)
where P denotes profit, R is revenue, C is cost, Var is the variance,
and Cov is the covariance. The covariance between exchange rate
movements and exporters' costs is likely to be relatively low (and,
therefore, the risk is likely to be relatively high), since exporters can-
not easily cut factor payments that have been contractually set. The
longer the production lag, the greater the exporter's exchange risk.
Consequently, exporters of specialized manufactured products (i.e.,
goods with long production lags) have a particular incentive to in-
voice in their home currencies. Under foreign currency invoicing, the
covariance between an importer's receipts and unforeseen exchange
rate changes is likely to exceed the covariance between an exporter's
costs (i.e., factor payments) and exchange rate variations. Importers
are often in a position to guard against currency fluctuations by
passing on the consequences of unfavorable exchange rate move-
ments (i.e., depreciation) to their customers in the domestic market.
590 TAVLAS
Table 3. Exports of Goods and Services as Percent of World Exports
1980 1985 1990 1994 1995
France 7.4 6.4 7.3 6.4 6.3
Germany 9.2 8.9 11.1 9.3 9.4
Japan 6.2 8.5 7.6 8.5 8.1
United Kingdom 6.1 5.7 5.5 5.1 5.1
United States 11.4 12.4 12.5 13.3 12.7
Source: World Economic Outlook data bank.
This course of action is most practical in small, open economies
where a large, importing-competing domestic industry does not ex-
ist (see Tavlas, 1991: 6-8).
Data on the share of world exports of goods and services for five
industrial countries during 1980 to 1995 are provided in Table 3. As
shown in the table, the United States is the world's largest exporter.
In 1995, its exports of goods and services accounted for 12.7 percent
of the world total compared with 11.4 percent in 1980. Germany
ranked second in 1995 with a 9.4 percent share and Japan third with
an 8.1 percent share. Table 4 reports shares of exports of goods by
SITe product category for 1980, 1990, and 1995. In 1995, exports of
manufactured goods comprised 51.9 percent of US exports. This out-
come compares with 72.0 percent for Japan, 50.9 percent for Ger-
many, 41.7 percent for the United Kingdom, and 39.6 percent for
France. Although the share of such exports for the United States
rose significantly compared with the 42.1 percent share recorded in
1980, substantial increases were also recorded by the other countries
included in Table 4. Japan registered the largest gain, with the share
of such exports rising from 53.2 percent in 1980 to 72.0 percent in
1995. In terms of the magnitude of exports of manufactured goods,
in 1995 Japan had the highest total of $309 billion, followed by the
United States with $298 billion, and Germany with $261 billion.
To summarize, the foregoing discussion of the determinants of in-
ternational currency use helps explain the use of the US dollar in-
ternationally.
1. In terms of inflation performance since 1973, that of the Unit-
ed States has been average compared with those of other in-
dustrial countries. Germany and Japan, for example, have con-
sistently achieved lower inflation rates (and, in the case of
Germany, lower inflation variability) than the United States.
2. US financial markets are the world's largest and have, there-
by, contributed to the dollar's widespread use.
3. The United States is the world's largest exporter. The position
INTERNATIONALIZATION OF CURRENCIES 591
Table 4. Shares of Exports by Product Category (In Percent)
Product Group and Exporter 1980 1990 1995
Agriculture
France 16.2 15.6 15.0
Gennany 5.5 5.8 5.7
Japan 1.3 2.1 0.5
United Kingdom 7.3 8.2 8.6
United States 17.8 14.0 10.7
Raw materials and energy
France 8.4 5.4 4.4
Gennany 6.4 3.4 3.5
Japan 2.1 1.3 1.5
United Kingdom 17.0 10.4 7.1
United States 13.7 10.9 8.4
Chemicals
France 9.0 13.7 9.6
Germany 10.9 12.7 10.7
Japan 4.5 5.5 6.2
United Kingdom 8.0 13.6 10.8
United States 8.2 10.5 9.3
Intermediate manufactured goods
France 19.3 15.5 14.7
Gennany 18.8 15.8 15.7
Japan 22.4 11.3 10.6
United Kingdom 20.0 14.9 13.5
United States 9.7 7.5 8.3
Machinery and transport equipment
France 34.0 37.7 39.6
Gennany 45.2 49.3 50.9
Japan 53.2 70.7 72.0
United Kingdom 35.0 38.0 41.7
United States 42.1 46.6 51.9
Consumer
France 13.2 12.1 16.7
Gennany 13.2 12.8 14.0
Japan 16.6 9.2 9.2
United Kingdom 12.7 14.9 18.6
United States 8.5 10.5 11.3
Source: Data Resources. Inc., World Trade Model databank.
of the United States as the world's largest exporter of goods
renders a basis for the widespread holdings of liquid dollar li-
abilities by foreigners to enable them to execute their dollar-de-
nominated imports, effecting familiarity with the dollar as an
international numeraire.
4. Finally, Japan is the world's largest exporter of differentiated
manufactured products. The United States, however, is close
592 TAVLAS
behind in second place followed by Germany. As will be shown
below, however, the yen has not yet emerged as a strong rival
to the dollar. This outcome is due to the fact that the Japanese
government in the past discouraged the international use of the
yen out of concern that it would not be able to control domestic
monetary conditions. Specifically, the Japanese government
was concerned that shifts by foreigners in preferences could
lead to large capital flows, thwarting the ability of the Bank of
Japan to attain its monetary-policy objectives.
RECENT TRENDS
Background
The US dollar emerged as an international currency following the
outbreak of World War I (Bergsten 1975; Frankel, 1992). The period
from 1914 to 1931 saw the dollar gain on the pound sterling as the
principal international currency-a process that was accelerated
when Britain suspended convertibility in 1931. The period of dollar
dominance appears to have begun in the aftermath of World War II,
particularly in light of Britain's unsuccessful attempt to restore con-
vertibility of sterling in 1946 (Bordo, 1993: 43-45). By the mid and
late 1970s, the dollar's share of international reserves had risen to
a peak of nearly 80 percent. In order to discern the use of the dollar
since then, and to understand how the various determining factors
have combined to influence the international use of the dollar, data
are presented pertaining to the international use of the dollar main-
ly since 1980.
The Dollar as a Medium of Exchange
Trends in the volume of currencies on foreign exchange markets can
be used as proxies for trends in the relative importance of currencies
as units of accounts and mediums of exchange. Data on turnover in
the interbank markets are available from surveys conducted by cen-
tral banks in April 1989, April 1992, and April 1995, and reported by
the Bank of International Settlements. These data are summarized
in Table 5. Since individual currencies are counted twice by defini-
tion, the sum of transactions in all currencies amounts to 200 per-
cent of the total. Including. currency futures and options, average
daily foreign exchange turnover was $620 billion in 1989, $880 bil-
lion in 1992, and $1,130 billion in 1995. Between 1989 and 1995, the
proportion of trading involving the dollar on one side declined by 7
percentage points to 83 percent. The dollar's share, however, rose by
INTERNATIONALIZATION OF CURRENCIES
Table 5. Use of Selected Currencies on One Side of Transaction as a
Percentage of Global Gross Foreign Exchange Market Turnover!
(Percentage Shares)
593
Currency April 1989 April 1992 April 1995
U.S. dollar 90 82 83
Deutsche mark-' 27 40 37
Japanese yen 27 23 24
Pound sterling 15 14 10
French franc 2 4 8
Swiss franc 10 9 7

Canadian dollar 1 3 3
ECU 1 3 2
Australian dollar 2 2 3
Other EMS currencies 3 9 13
Currencies of other 3 3 2
reporting countries
Other currencies 19 8 8
All currencies 200 200 200
lNumber of reporting countries in 1989: 21; and in both 1992 and 1995: 26. Data for 1989 and data for
Finland in 1992 include options and futures. Data for 1989 cover local currency trade only except for US
dollar, deutsche mark, Japanese yen, pound sterling, Swiss franc, and ECU. The figures relate to gross
turnover because comparable data on a "net-gross" or "net-net" basis are not available for 1989.
2Data for April 1989 exclude domestic trading involving the deutsche mark in Germany.
Source: Bank for International Settlements.
1 percentage point in the three years to 1995, while the share of the
deutsche mark, the second most actively traded currency, fell by 3
percentage points. The data show that foreign exchange market
trading is still dollar-denominated; the dollar's share in 1995 was
larger than that of the next four competitors (deutsche mark, Japan-
ese yen, pound sterling, and French franc) combined.
The Dollar As an Investment and Borrowing Currency
In order to assess the performance of the US dollar vis-a-vis other
currencies in international markets, Table 6 presents data on the use
of the dollar and other currencies as a store of value and a unit of
account during 1981-1996. The data in the table classify the use of
currencies into three types of instruments: (1) external bank loans,
which include foreign and international bank loans; (2) external
bond issues, which include foreign and international issues and spe-
cial placements; and (3) Euro-currency deposits. These data show
that the United States has dominated the market for external bank
loans; in 1996, the dollar accounted for almost 75 percent of such
loans, down slightly from the first half of the 1980s. With regard to
external bond issues, and Euro-currency deposits, the dollar's share
594 TAVLAS
Table 6. Currency Shares of External Assets (In Percent)
Asset Type and 1981-84 1985-89
Currency Average Average 1990 1992 1994 1996
1
Exrernal bank loans
US dollar 83.3 67.9 84.5 75.4 80.7 74.3
Deutsche mark 1.7 5.8 2.1 1.8 1.1 4.5
Japanese yen 5.9 8.1 1.2 1.4 0.2 0.2
Pound sterling 3.1 10.3 4.1 1.9 8.6 12.6
Swiss franc 1.2 1.1 0.6 0.3 0.4 0.5
ECU 1.3 2.9 3.9 15.0 6.4
.
0.2
Other 3.5 3.9 3.6 6.9 3.8 7.3
External bond issues
US dollar 63.2 47.6 33.3 36.9 37.5 42.9
Deutsche mark 6.3 7.9 8.3 10.4 7.8 14.0
Japanese yen 5.7 10.4 13.5 11.2 13.3 8.8
Pound sterling 3.4 7.8 9.5 7.6 8.8 8.8
French franc 1.0 4.3 7.5 7.0 6.4
Swiss franc 14.7 10.3 10.5 5.8 4.8 3.3
ECU 1.7 4.2 8.1 6.8 2.0 0.7
Other 5.0 10.9 18.9 14.0 16.5 16.8
Eurocurrency deposits
US dollar 74.0 61.5 51.9 50.4 46.7 44.9
Deutsche mark 11.4 13.4 13.3 16.4 17.4 15.3
Japanese yen 1.8 4.9 5.5 4.5 5.3 5.6
Pound sterling 1.4 1.4 3.4 3.6 3.5 3.3
French franc 0.9 1.3 1.3 3.8 3.4 3.9
Swiss franc 5.8 6.3 5.4 4.8 4.3 4.2
ECU 0.5 2.7 3.0 5.2 4.2 2.9
Other 4.3 7.1 16.2 11.3 15.7 19.9
lData on eurocurrency deposits are through September 1996.
Sources: BIS International Banking and Financial Market Developments, and OECD Financial Market
Trends, various issues.
of both markets was somewhat above 40 percent in 1996, down
sharply from levels of the early 1980s, but well above the shares of
other currencies.
The importance of currencies as stores of value and units of ac-
count can also be gauged by their use of reserve assets. Table 7 pre-
sents currency shares in official holdings of foreign exchange by all
reporting countries. The data show that the share of the dollar fell
modestly from about 69 percent in 1980 to about 62 percent in 1995.
The deutsche mark was in second place in 1995 with a 14.2 percent
share. Between 1980 and 1995, the largest gain was registered by
the Japanese yen; its share almost doubled, reaching 7.4 percent.
The yen's share peaked, however, in 1990 when it reached almost 9
percent, before falling over the next five years.
INTERNATIONALIZATION OF CURRENCIES 595
Table 7. Official Holdings of Foreign Exchange
1
1980 1982 1984 1986 1988 1990 1992 1994 1995
US dollar 69.4 69.9 69.1 65.9 63.3 56.0 62.7 63.3 61.5
Deutsche mark 14.8 12.2 12.5 14.5 15.6 18.7 14.5 15.5 14.2
Pound sterling 2.9 2.3 2.9 2.5 2.7 3.4 3.4 3.8 3.5
Japanese yen 4.3 4.6 5.7 7.8 7.6 8.8 8.5 8.5 7.4
French franc 1.7 1.0 0.8 0.8 1.0 2.4 2.5 2.1 1.9
Swiss franc 3.2 2.6 2.0 2.0 1.9 1.4 1.2 1.1 0.9
Netherlands 1.3 1.1 0.7 1.1 1.1 1.1 0.6 0.5 0.5
guilder
Unspecified 2.3 6.3 6.3 5.3 6.9 8.2 6.5 5.1 10.1
currencies!
End of year data. ECU-dollar swaps included as dollars.
Source: IMF Annuol Reports. various issues.
WHAT ABOUT THE FUTURE?
As the world's dominant international currency, the dollar plays the
role of anchor of the international monetary system. It is the unit of
account in which most prices of primary products and financial as-
sets are denominated in world markets. When importers or investors
need foreign exchange to make payments, they often either pay in
dollars or use the dollar as a vehicle currency. When international
investors, including central banks, need to invest their funds in a
safe haven, the dollar is often the currency of choice.
What about the future? In order for the dollar to remain the dom-
inant international currency, several conditions would need to be ful-
filled. First, the US monetary authorities will need to solidify their
anti-inflation credentials. Second, the dollar has benefited from the
absence of rival currencies issued by economies with structural char-
acteristics similar to those of the US economy.
It is, therefore, worth conjecturing about the implications of Eu-
ropean economic and monetary union (EMU) and the adoption of a
single European currency (the euro) for the dollar's dominant posi-
tion (Kim, 1993: Chapters 4 and 14; EMI, 1995). Ifthe euro is backed
by a credible monetary policy, it will play a more important global
role than its constituent European currencies play today. Central
banks will want to hold some of their reserves in euros, and finan-
cial markets will conduct more transactions in the new currency.
Both changes will primarily occur at the expense of the dollar.
If all fifteen European Union (EU) countries were eventually to
form a single currency area, then over 60 percent of their current for-
eign trade would be reclassified as domestic so that the EMU would
596 TAVLAS
be a much more closed economy than those of any of its individual
members. Also, the EU would emerge as the world's largest econo-
my (accounting for about 30 percent of world output) as well as the
largest exporter. It would be highly diversified and, thus, less sus-
ceptible to external shocks than any of its constituents. Monetary
union would help make European financial markets broader and
more liquid. Despite the boost that EMU is likely to provide for Eu-
ropean capital markets, the supremacy of the US capital market is
likely to be unchallenged. Recall that US capital and stock markets
are each about as large as the combined total of the corresponding
markets of the other Big Seven industrial countries. Moreover, EMU
on its own will do little to decrease Europe's unemployment problem;
the average EU-wide unemployment rate is expected to remain in
the double digits into the beginning of the next century. Europe's un-
employment problem requires structural policies to increase the flex-
ibility of labor and product markets. In general, EMU would help
create a large financial market, an economy that could be less sus-
ceptible to external shocks than any of its individual member states,
and one that is the world's largest exporter. In these latter respects
it could match the economy of the United States and-providing the
European central bank establishes strong anti-inflation creden-
tials-the euro could, over time, emerge as a leading international
currency.
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