Europe's dream of a global reserve currency – Commerzbank

Yesterday ECB President Christine Lagarde gave a speech in Berlin. It was about how the euro could possibly replace the dollar as the dominant global currency in the future. The speech is worth reading, Commerzbank's Head of FX and Commodity Research Ulrich Leuchtmann notes.

Euro may struggle to become the next reserve currency

"Lagarde is right, in my opinion, when she says: 'A currency's exposure to trade is especially important, as it provides the initial pathway to wider international use.' Reserves are held so that, in the worst case scenario of a balance of payments crisis, they can secure a country's imports. Their adequacy is therefore measured in 'months of import coverage,' for example. If the whole world were to stop trading in dollars and switch to another currency, central banks and finance ministries would also have to shift their reserves into that currency. The dollar-centric world currency 'order' is therefore merely a consequence of its wide use in cross-border transactions by third countries."

"Early dissidents from the USD-centric system would have to pay higher transaction costs if they wanted to use an unusual means of transaction. This is why the dollar-centric system is stable and has survived crises. It is therefore not a question of whether the euro would be a slightly better global reserve currency. It could only replace the dollar if continued dollar use became completely unacceptable to a sufficient number of existing users, who would then be willing to bear the early dissident costs. I therefore believe that US sanctions policy could become the biggest risk factor for the dollar's dominance if it becomes unacceptable for large economic areas (e.g., the EU)."

"Just because the US runs permanent current account deficits and therefore constantly transfers dollars abroad, this does not create a shortage of US dollars in the rest of the world, which constantly needs more of the world's reserve currency. If the euro were the world's reserve currency tomorrow and the eurozone continued to run current account surpluses, there would be a shortage of euros in the rest of the world: to pay for eurozone exports, the rest of the world would have to constantly transfer the new world reserve currency to its issuer – the eurozone. As a result, the euro would appreciate – far more than would be justified from a domestic perspective."