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Monday, Nov. 20, 2000

JAPANESE PERSPECTIVES

Euro attracts global audience as option to dollar-based trade


European, Japanese and U.S. authorities launched joint euro-buying intervention in late September just before a meeting of the International Monetary Fund, when the unified currency dipped below 0.85 against the dollar. Even though they intervened on a fairly large scale, market concern over the euro's downside risk has remained unabated.

The joint action, in effect, seems to have illustrated the limits of monetary intervention when attempting to in- fluence the massive flow of private-sector funds in the market. Despite such misgivings, however, the European Central Bank reportedly made a solo attempt earlier this month to support the flagging unit.

What are the reasons behind the ECB's moves? First of all, the central bank is undoubtedly desperate to avoid losing global trust in the euro and to prevent it from sliding further.

Since its launch in January 1999, the euro has declined 28 percent against the dollar and 30 percent against the yen. Its initial strength may have been bloated by euphoria over the launch of a new major currency, but it is undeniable the exchange is now extremely low.

Second, European authorities are apparently concerned that the euro's continued depreciation may raise doubts not only about the currency, but about European integration itself. The euro's weakness is more than an economic problem; it is a political issue that involves transferring the EU member nations' sovereignty over currency.

In December, France, the current chair of the European Union, is scheduled to hold the Inter-Governmental Conference in Nice, where participants will discuss special voting rights -- a measure aimed at accelerating political integration -- and expanding the scope of such ratings.

It is believed the euro's decline has been caused by a "widening" process that has far outpaced the "deepening" process.

As the EU widens in scope, it will naturally become more difficult to maintain the equality principle when decisions affecting member countries come to be made. If the euro drops further during the December conference, it may dampen enthusiasm for political integration, which is a scenario EU officials wish to avoid at all costs. This is the context in which the debate over adding new members has been postponed.

The third reason for the ECB's actions is its need to establish leadership. A feeling widely supported among currency market players is that the euro's weakness lies in the fact that the ECB lags behind the Bundesbank in its experience and decisiveness.

Fourth, the euro zone as a whole needs to streamline its excessive dollar holdings. Each of the EU members, within the range of the Exchange Rate Mechanism, holds dollar reserves to stabilize the exchange rates of their own currencies. But the launch of a single currency has made those reserves unnecessary. Something must be done about this situation in light of the downtrend in U.S. stock prices anticipated in the coming months and a possible review of the "strong dollar" policy under a Republican administration headed by George W. Bush.

The fifth factor is the impact of high crude oil prices. Crude oil is traded in dollars, and a weak euro has accelerated the rise in domestic prices within the euro zone. A euro-buying operation is one possible way of stemming the surge.

In this connection, it must be noted that Iraq is attempting to switch to the euro as its currency for settling oil exports, and that Venezuela is reportedly planning to follow suit. Euroland has a lot to gain from this development because it will eliminate currency exchange risks.

But for such a scheme to work, it is essential to stabilize the euro against other major currencies.

The United States has in the past frozen the dollar balances of countries with whom relations have deteriorated and still does the same with some nations. With no end in sight to political uncertainties in the Middle East, it is inevitable that some countries will switch from dollars to other currencies to settle their cross-border trade.

China once had its dollar assets frozen when it intervened in the Korean War. It would be interesting to see Beijing's response today.

Diversification of foreign currency reserves will help avert the various risks involved in holding U.S. dollars, including the political risks mentioned above. When the new U.S. president takes over from Bill Clinton in January, he will have to deal with this issue.

Since it would be too much to ask the U.S. dollar -- the currency of a nation that has accumulated a gaping current account deficit -- to cover the financial transactions of the entire world, we must realize that the euro, despite all its problems, is on its way toward becoming a world currency.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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