Euro as Second World Currency but Adoption Could Hurt Eastern Europe

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Global Trade, Macroeconomics

With so much talk recently about the role of the US dollar as the world’s reserve currency and China’s suggestion that an IMF backed global currency should be considered for the future it is interesting to review how the Euro has been fairing as the world’s second most important currency.

The answer is comparatively well considering the financial travails many of the Eurozone countries have been facing this year. Indeed it is the condition of many of those countries bordering the Euro zone to the east and south that cause the greatest concern and if danger exists for the single currency then this is where it comes from.

Why would the central and east European economies present a problem for the euro zone economies and currency? Because they are fast becoming de facto euro zone economies without adopting the euro and hence without any say over monetary policy. Latvia is already facing a sovereign debt crisis as it failed this month to sell a single bill at a $100m treasury auction according to the Telegraph. Fitch ratings estimates Latvia’s foreign debt (mostly mortgages) as equal to 320% of foreign reserves. House prices have already fallen 50% and there is talk of a 15% currency devaluation. If Latvia is like this, so is Estonia, Lithuania, probably Bulgaria and so it goes on. According to an FT report, almost all deposits in Montenegro were in Euros, and slightly more than half in Croatia, more than half of loans in Latvia, Bulgaria and Lithuania were denominated in the EU’s single currency putting borrowers at huge risk to rising debt costs if their local currency depreciates against the Euro. With central and eastern European economies set to contract by 5.8% this year according to the latest IMF report (only Russia is set to contract more drastically) the currencies have already depreciated substantially and could slide further if the countries experience a wave of bank defaults as many fear.  West European banks have $1.3 trillion exposed to the region; a wave of defaults would undermine western banks and the currency.

The Euro has gradually become the currency of first choice for countries bordering the EU and second choice for those further afield, such that globally the Euro’s share of debt securities rose to 32.2% at the end of 2008, while its share of known central bank reserves, the measure of global currency status, hit 26.5%. According to the European Central Bank the dollar still retains about a 60% share of both categories ” where does that leave the Chinese Yuan? A long way from anywhere is the answer.

–Stuart Burns

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