For further information:
Gail D. Fosler
(212) 339-0301
The Conference Board
[email protected]
For Release Wednesday, April 8, 1998 at 6:30 P.M. ET
Release #4411N
THE EURO WILL RISE IN IMPORTANCE AMONG GLOBAL CURRENCIES
But It Won't Achieve Reserve Status and Challenge The Dollar
The euro is emerging as a strong and stable currency that will increase its relative parity with the U.S. dollar, according to an analysis released today by The Conference Board.
"A single currency can greatly increase the breadth and efficiency of the European marketplace," says Gail D. Fosler, senior vice president and chief economist of The Conference Board in the latest issue of StraightTalk, her newsletter prepared exclusively for Conference Board associates. "The price/value transparency that comes with a single currency will assist in the transformation of European capital markets into global sources of business finance. This will hasten the decline of bank credit as a major source of business borrowing, as it has occurred already in the U.S."
Fosler notes that the European union represents an economic region more similar to the U.S. than to any of its individual countries. A key result is that European monetary policy will no longer be as heavily influenced by Germany, which has been responsible for driving up European currencies in relation to the dollar.
She says the strength of the European economy will become an increasingly important consideration in determining monetary policy, with the European Union resembling the U.S., where monetary decisions are primarily based on domestic considerations.
Both the U.S. and the European Union are comparable in size, accounting for roughly 20% of world Gross Domestic Product and about 15% of world exports (excluding intra-EU trade). In addition, both the U.S. and EU government deficits are rapidly shrinking, with all the likely euro participants reporting budget deficits less than 3% of GDP. Inflation rates in both regions are virtually identical.
BUT THE DOLLAR WILL STAY ALMIGHTY
While the dollar has given way to other currencies, it still accounts for more than one-half of all foreign exchange reserves and its share is rising. The euro is not likely to challenge the dollar as a reserve currency as long as European trade surpluses are growing and until European capital markets effectively compete with U.S. markets. A growing trade surplus means that the supply of euro currency in the global economy is shrinking. The narrow breadth of European capital markets restricts the availability of euro-based securities for purchase.
"For a currency to assume significant reserve status, the region must be willing to run a neutral-to-deficit trade balance and have security markets of sufficient size so that the currency can be exchanged for return-bearing assets," concludes Fosler. "At the moment, Europe appears to be on a course toward a relatively strong currency, but one that is of limited global significance."
WHAT THE EURO WILL DO FOR EUROPE
The euro will have a powerful impact in transforming Europe and making it more dynamic. The restructuring of European capital markets into a pan-European source of capital with a wide range of investment opportunities and many regional centers will be the most important change. Fosler notes that the euro will remove the exchange rate risk of moving capital among markets and permit the easy comparability of financial asset prices. Also, with the elimination of currency risk, debt markets will increasingly differentiate issues on the basis of credit risk, opening European markets to a wider range of borrowers and making them a more integral part of the global investment process.
By introducing competition based on perceived long-run rates of return on capital, the transformation of European capital markets could help to accelerate other important consequences of the euro, such as a significant increase in the size, content, and competitiveness of European product markets and the mobility of labor among Europe's highly fragmented labor markets.
WHY FOREIGN INVESTMENT IS VITAL
Economic vitality is as important as economic policy in determining currency values, The Conference Board newsletter points out. Since 1993, Europe has maintained a rapidly growing trade surplus that reached $175 billion in 1997. Under ordinary circumstances, this would enhance the European currencies. But these trade surpluses have been undercapitalized because the European domestic market has been weak. One result: the growth in domestic investment has lagged well behind the U.S. and much of the rest of the world.
"An important lesson from emerging market turmoil, which also applies to Europe, is that the shortest route to a strong currency is a heavy flow of foreign investment," says Fosler. "For the euro to be a truly strong currency, the European economies will have to find a middle ground between the current export-dominated growth and an economic structure that would invite a significant increase in domestic and foreign investment and ultimately domestic market growth. Otherwise, Europe will continue to trail the rest of the world in growth and resource utilization and will be required to support the euro through tight economic policies, including high real interest rates." -30-
Source: StraightTalk, Volume 9, Number 3, March 1998, The Conference Board
RSS