The Euro, The Dollar and the Global Financial Crisis

Currency challenges seen from emerging markets

Miguel Otero-Iglesias

• Publisher: Taylor & Francis
• Year: 2014
• eBook ISBN: 9781317636755
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

This book analyses how financial elites in key dollar-holding emerging markets perceive the contest between the euro and the dollar for global currency status. It also assesses how far the Eurozone has gone in challenging US hegemony in monetary affairs through the prism of these elites.

Drawing on Chartalist and Constructivist theories of money, the author provides a systematic approach to studying global currency dynamics and presents extensive original empirical data on financial elites in China, Saudi Arabia, the UAE and Brazil. The author demonstrates, amongst other things, how the gradual ascendance of a structurally flawed currency like the euro has highlighted the weaknesses of the dollar ad how the euro has demonstrated that sovereignty sharing in monetary affairs is possible and that the international monetary system can be a multicurrency and multilateral system.

In this highly innovative and important book, Otero-Iglesias shows the importance of studying financial elites in Brazil, China and the GCC countries in order to understand the full impact, material and ideational, of the euro in the transformation of the IMS. It will be vital reading for students and scholars of International Political Economy, International Economics, International Finance, Economic History, Economic Sociology, International Relations, Comparative Political Economy and Comparative Politics.

1 Introduction

The euro challenge seen from emerging markets

The global financial crisis initiated in the United States (US) in 2007, and its damaging recessionary aftermath, have raised questions about global monetary leadership. The bloating structural twin (current account and budget) deficits of the US, which for many, especially in China, have been the main source of the crisis, are seen as a major threat to the stability of the world economy (Chin and Wang 2010; Lin 2013). As a consequence, the centrality of the US dollar in the international monetary system is highly contested and policymakers around the world are looking for possible alternatives (Zhou 2009; Angeloni et al. 2011; Camdessus et al. 2011; Sanya Declaration 2011). The obvious beneficiary of the troubles of the dollar should be the euro, the second most used international currency. Unfortunately, the effects of the global crisis, which triggered the subsequent European banking and sovereign debt crisis, have equally shown the structural flaws of the European currency, jeopardising its potential to seriously challenge the ‘greenback’. From a euro-sceptical point of view, dominant in the Anglo-American world, this crisis is just the beginning of the end of the single currency, an experiment in monetary sovereignty pooling that never had a chance to survive (Jonung and Drea 2009). By contrast, for euro-optimists this crisis is the golden opportunity that was required to integrate further European Economic and Monetary Union (EMU), and consequently to make the euro stronger and more resilient for the future (Bergsten 2012).

The euro vs. dollar debate is not new. Even before the single European currency arrived as ‘virtual’ money to the markets in 1999, and as ‘real’ coins and bills to the streets of Berlin and Paris in 2002, there were proponents and detractors of EMU. Economists such as Bergsten (1997), Mundell (1998) and Portes and Rey (1998) announced that the creation of the euro was the greatest challenge to US hegemony in international monetary affairs since the US dollar took over from British sterling in the years following the First World War. Pointing to the size and exporting capacity of the Eurozone economy and the strong mandate for price stability attached to the European Central Bank (ECB) in the 1992 Maastricht Treaty, they predicted the euro would quickly compete with the American currency for global currency status. These predictions were greeted favourably in Europe, especially by the French, who, since Charles de Gaulle in 1960s, have tried to mitigate, if not eliminate, the ‘exorbitant privilege’ that the centrality of the dollar offers to the US (Kirshner 1995; Eichengreen 2008). In this regard, the euro has never been seen by European policymakers only as an economic project to avoid exchange rate instabilities, to enhance and consolidate the common market, and to protect it better from external shocks. It has also been conceived as a political project that would strengthen European integration and consequently make Europe more independent and powerful in shaping global economic and monetary governance (Dyson and Featherstone 1999; Jabko 2006; Marsh 2009).

However, not everyone was ‘optimistic’ about the prospects of the euro at its birth. Other economists such as Dornbusch (1996), Cooper (2000) and Kenen (2002) identified at an early stage three main obstacles that would hamper the rise of the euro. The first limitation refers to the difficulties of managing asymmetric external shocks in a currency union which falls short of being an Optimum Currency Area (Mundell 1961, 1973; Kenen 1969). This is especially true when there is no centralised budget able to transfer large funds from better-off to worse-off regions within the Union. The debt crisis in the Eurozone periphery, and the difficulties encountered to terminate it, demonstrate this point in practice. The second shortcoming is linked to the first and points to the fragmentation of the European sovereign debt markets. For euro-sceptical authors it will be very difficult to see the euro challenge the predominance of the dollar until the Europeans integrate their debt markets and issue a common debt instrument equal to the Treasury bill of the US, the safest and most liquid financial instrument in the world. In this specific area, and this might be considered counter-intuitive, the Eurozone debt crisis has increased the euro’s chances of becoming a global currency. To fund the rescue packages for its periphery, the Eurozone has started to issue for the first time debt instruments backed by the Eurozone as a whole through first the European Financial Stability Facility (EFSF) and later the permanent European Stability Mechanism (ESM). Thus, the Eurozone has finally agreed to issue what are de facto Eurobonds in order to lower the financing costs of those countries that are in financial need.

Finally, the third obstacle is path-dependency. New currencies can only overtake incumbent international currencies if the latter are perceived to underperform as the main anchor of the system for a protracted period of time due to policy mistakes of the issuing country or a steady decline in its economic and political power. In this area the jury is still out. Increasingly, the dominant belief is that US economic and political power is declining in relative, although not in absolute terms (Cohen 2010; Bénassy-Quéré and Pisani-Ferry 2011; Eichengreen 2011; Lin 2013). But then, the same was argued before in the 1960s and 1980s and the US was able to reinstate its dominant position (Cox 2001). On the policy front what really dominates is profound uncertainty. The effects of the global financial crisis have been so deep and protracted that literally nobody knows whether the US authorities have managed it in the best possible way. It is difficult to know, for instance, the mid-to-long-term effects of the Federal Reserve’s (FED) Quantitative Easing (QE) programme. Equally it is hard to predict whether the continuous political brinkmanship games between Democrats and Republicans in the US Congress on lifting the US public debt ceiling, and the impending risk of default, will in the mid- to long term seriously damage the reputation of the US dollar. What is certain is that the US growth model based on deregulated finance which led to the crisis, the extremely lax monetary and fiscal policies adopted by Washington to come out of the crisis, and the procrastination of its policymakers to solve the debt problems enhanced because of the crisis have triggered considerable criticism not only from Europe, but especially from the BRICS (Brazil, Russia, India, China and South Africa).

Given the current unstable economic outlook and the uncertainty that has surrounded the fate of both the dollar and the euro, it is no wonder that the disagreements of analysis and prediction on the possible euro challenge to the dollar have continued up to the present crisis, not only in the field of International Economics (Chinn and Frankel 2008; De la Dehesa 2009; Papaioannou and Portes 2008 vs. Posen 2009) but also in the International Relations (IR) and International Political Economy (IPE) literatures. Scholars such as Calleo (1999), Kupchan (2002), Leonard (2005) and Eichengreen (2011) have argued that the consolidation, and possible survival, of the euro represents better than anything else the gradual formation of a united European superpower, while authors such as Cafruny and Ryner (2007), Konings (2008) and Cohen (2010, 2013) have responded to these predictions by pointing to the structural weaknesses of the European project, still politically and economically divided, and as a consequence, still tracking behind the US in key fields such as credit creation (finance) and military protection (security), arguably the two most important of the four pillars (including production and knowledge and ideas) of Susan Strange’s (1994) groundbreaking ‘structural power’ framework.

The more recent banking and sovereign debt crisis in the Eurozone (2010–ongoing) seems to have settled the debate. Hardly anyone believes that the European currency is currently able to challenge the greenback. But this verdict is too premature and misleading. The euro might fail, but it might also come out of this crisis stronger. This is certainly what China hopes and it is doing its part to see that happen. Thus, it is very likely that euro-sceptics and euro-optimists might continue their debate for many years to come, and perhaps none of them will be proven definitely right for some time (Cohen 2012). The aim of this book is to contribute to this debate. Its main argument is that the euro has not been able to challenge the dollar as the main international currency from a pure material analysis, but it has done so from an ideational point of view, and by doing so it has enhanced (although not optimised) European monetary power in global monetary governance. In other words, what my research shows is that a structurally weak euro has asked some tough questions to the once almighty dollar. In this regard, the euro has effectively challenged the unipolarity of the dollar. It has exposed its deficiencies and thus started a race towards a multicurrency system.

By developing this argument, I tackle two important shortcomings in the existing literature. First, most research in the euro vs. dollar debate is eminently rationalist and/or materialist. The Economics literature is exceedingly based on rational-choice approaches which draw on narrow economic variables, while the IPE literature has a tendency to focus predominantly on the structural-material conditions in the International Monetary System (IMS). In both fields the analysis is generally overly theoretical and, when it comes to agential behaviour, highly speculative. Hence, the ideational impact of the euro is generally overlooked. Second, when studying the euro challenge to the dollar very few authors¹ in the debate have paid attention to the views and perceptions of policymakers and financial elites of key dollar-holding countries such as China, which today holds around $4 trillion in foreign reserves and is the main creditor to the US; important geostrategic countries such as the oil exporting states of the Gulf Cooperation Council (GCC), which are not only the suppliers of the main source of energy in the world economy but also large holders of foreign reserves; and economic and financial upcoming powerhouses with increasing regional and global geopolitical significance such as Brazil. These three regions (which form the three case studies of this book) are systemically important in the IMS. Consequently, the views and portfolio management strategies on the dollar and the euro of their political and financial elites cannot be overlooked. Thus, the original contribution of this book lies in the fact that it is an empirical and cognitive study of the perceptions and intentions of these elites through extensive, in-depth fieldwork in the aforementioned regions.

Methodologically, the primary objective is to move away from narrow quantitative economic analyses. While this study engages with this literature, it offers systematic empirical fieldwork analysis focused primarily on financial elite interviews in order to grasp qualitatively how key agents in dollar-holding emerging markets subjectively perceive the impact of the euro in the IMS. Since the euro has always been both an economic and a political project it would be awkward to analyse its international currency trajectory using only strict economic variables. Fortunately, the field of IPE has always analysed currencies in a wider scope than the traditional and orthodox functions of money as a unit of account, medium of exchange and store of value. While these quantitative and measureable areas are important to consider, they do not cover all the dimensions of money. Money is based on social relations loaded with notions of power that cannot be overlooked.

Money is essentially credit, and as the same word indicates, money is based on credo, thus on social trust and faith. On the assumption that the holder of a coin and a banknote will receive back what is owed to her, under the implicit guarantee of the sovereign political authority that controls a given monetary space (Goodhart 1998; Ingham 2004; Martin 2013). Hence, a Chartalist understanding of money as developed in this book shows that when this central authority is absent as today in the Eurozone or malfunctioning as in the case of US, then this promise is seriously put into question by market participants. Thus, money is not a neutral instrument of exchange as neoclassical economics (based on a Metallist understanding of money) would interpret it; its abstract value, and its ideational symbolism are socially constructed and therefore (inter)subjectively formulated and reacted upon both on material and ideational grounds. Economic agents develop their own perceptions and interests on the future of the dollar and the challenge of the euro not exclusively on objective and rational predictions and calculations. They are influenced by the set of ideas, norms, beliefs and institutions that surround them. As Blyth (2002: 42), drawing on John Maynard Keynes, argues, the economy ‘is as much a subjective construct as an objective reality’. This is especially true when analysing money, which has, inherently and ubiquitously, as much to do with politics as with economics, more so than ever in times of crisis (Kirshner 2003a).

Theoretical framework

Considering this political economy interpretation of money, this book covers, predominantly through qualitative methods, the economic, political but also the ideational dimensions of the ascendance of the euro as an international currency vis-à-vis the dollar, and in doing so, it demonstrates how this wider understanding is more appropriate to comprehend the full impact of the arrival of the euro upon the international financial system. Following the footsteps of Susan Strange and Charles Kindleberger, authors such as Kirshner (1995, 2003b), Cohen (2006) and Helleiner (2008) have in recent years developed theoretical frameworks that understand currencies as an extension of national sovereignties and their use overseas as one of the most visible symbols of influence and power in foreign affairs. With this study, I have endeavoured to find out whether this is also true of the union of states issuing the euro. In this sense, I have tried to go beyond the structural and material impact of the euro and also discover its symbolic footprint.

The analytical framework developed for this research is based on the emerging constructivist literature in IPE interested in situations of Knightian uncertainty (Blyth 2002; Abdelal et al. 2010). This type of uncertainty, prevalent in unique moments of major economic distress when economic agents ‘are unsure as to what their interests actually are, let alone how to realize them’ (Blyth 2002: 9), is commensurate to the context that has emerged in the aftermath of the global financial crisis. Throughout the timeline of this research (2008–13), which covers both the global financial crisis and the European banking and sovereign debt crisis, the financial elites investigated have been confronted with a series of major uncertainties. Who will carry the burden of the structural adjustment triggered by the crisis? Is the apparent decline of the US transitory or long-lasting? Until when will the US be able to increase its deficits? How do we confront possible inflation provoked by QE? Is the US trying to inflate away its debt? Will there be a run on the dollar? What can be done if it happens? Will the euro be around in ten years time? Will EMU develop into political union or break up? How do we move from dollar unipolarity to a multipolar system? These are the questions that financial elites in emerging markets are asking themselves right now without finding any concrete answers.

This sense of haziness has been palpable in most of the more than 120 semistructured financial elite interviews that I have conducted over the past five years with officials at central banks, ministries of finance, commercial banks, sovereign wealth funds, universities and think tanks in China, Saudi Arabia, the United Arab Emirates, Qatar and Brazil. Thus, as will be explained in Chapter 2, this is a moment of Knightian uncertainty, and as such it has the potential to produce a systemic shift in the institutional framework of the IMS. Ideas take here a prevalent role. As suggested by Blyth, id...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Illustrations
• Preface and acknowledgements
• 1 Introduction: The euro challenge seen from emerging markets
• 2 Reframing the euro vs. dollar debate
• 3 The material limits of the euro challenge to the dollar
• 4 The alternative of the euro and the negotiated status of the dollar
• 5 The euro’s ideational challenge to the unipolarity of the dollar
• 6 The Eurozone’s monetary power in reforming the floating dollar standard
• 7 Conclusion
• Index