the currency denomination of world trade after european monetary union

JOURNAL OF THE JAPANESE AND INTERNATIONAL ECONOMIES 12, 424–454 (1998)ARTICLE NO. JJ980417

The Currency Denomination of World Trade afterEuropean Monetary Union

Philipp Hartmann*

London School of Economics, Financial Markets Group and CEPR,European Central Bank, DG Research, Kaiserstrasse 29,

60311 Frankfurt, Germany

Received July 8, 1998

Hartmann, P.—The Currency Denomination of World Trade after EuropeanMonetary Union

This paper addresses the question of which role the currencies of the three majoreconomies in the world might play in global trade after European economic andmonetary union. Based on historical data about trade flows and invoicing practicesas well as ‘‘G-3’’ economies’ inflation records, it is argued that, most likely, theU.S. dollar will maintain its dominant role in trade denomination for quite anextended period of time after the European changeover. From the data discussed,the euro will immediately take on the role of the second most important tradevehicle currency, well in advance of the Japanese yen. Due to network effects, theeuro is likely to gradually expand its share in global trade invoicing thereafter,primarily at the expense of the dollar in Central and Eastern Europe, theMediterranean, and, perhaps, also in Asia. J. Japan Int. Econ., Dec. 1998, 12(4),pp. 424–454. London School of Economics, Financial Markets Group and CEPR,European Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt,Germany. 1998 Academic Press

Journal of Economic Literature Classification Numbers F19, F14, F33, F49, E41.

* This paper presents the results of research the author has done while being on the facultyof the London School of Economics. Any views expressed are only his own. It partly drawson an earlier working paper ‘‘The Future of the Euro as an International Currency: ATransactions Perspective,’’ issued by the Center for European Policy Studies (CEPS). Hewishes to thank Eiji Ogawa and Helene Rey, the participants of the TCER–CEPR–NBERConference on the ‘‘International Monetary Regime in the 21st Century’’ in Tokyo and thoseof the CEPS Working Party on ‘‘The Transition to the Euro’’ in Brussels, as well as CharlesGoodhart for comments and suggestions. Author’s mailing address: Philipp Hartmann, Euro-pean Central Bank, DG Research, Kaiserstrasse 29, 60311 Frankfurt, Germany. Fax: 149-69-1344-6000. E-mail: [email protected], or [email protected]. Any views ex-pressed are only the author’s own.

4240889-1583/98 $25.00Copyright 1998 by Academic PressAll rights of reproduction in any form reserved.

CURRENCY DENOMINATION OF TRADE AFTER EMU 425

1. INTRODUCTION

This paper discusses how the currency distribution of world trade invoic-ing may change with the introduction of the single European currency, themost important structural change in the international monetary systemsince the break-up of the Bretton Woods system of fixed exchange rates inthe early 1970s, and thereafter. Following the irrevocable fixing of exchangerates and the start of the single monetary policy in January 1999, the timetable of European Economic and Monetary Union (EMU) foresees thatin July 2002, at the latest, all participating countries will have completelyreplaced notes and coins of their earlier domestic currencies against euronotes and coins. In the interim period the local notes and coins remainlegal tender but simply as an expression of the new currency. However, mostwholesale transactions in the euro zone—such as money market trading andlarge-value payment system flows, stock market trading and settlement,etc.—will switch to euro right at the start (Schlesinger et al., 1996). Similarly,foreign exchange trading with outside currencies will be entirely in euro.

Table I illustrates the relative importance of the European Union (EU),the United States, and Japan for the global economy. In terms of GDP,population, international trade, money balances, and capital markets, all15 EU nations together build an economic unit at least as large as the U.S.economy and in many respects even larger than any other industrial countryin the world. The 11 EU countries which would build a ‘‘medium-size’’EMU have about the same size as the United States.1 By all these measuresJapan is clearly a smaller economy than the other two.

This picture faces a number of qualifications: First, current exchange ratedeviations from purchasing power parity (PPP) seem to favor the EU whenone currency (here the dollar) is used as the common denominator (seecolumn 3 of Table I). While, by the time of writing, it was not certain thatEMU would start with all 15 European Union countries, it is not totallyexcluded that, at some future date, Canada and Mexico could build amonetary union with the United States. Also, the capital markets figuresin the last column give an imprecise picture, because when securities mar-kets are distinguished from banking markets, the former are larger in theUnited States while the latter are larger in Europe (Prati and Schinasi,1997) and because EU markets are not yet as integrated as most of thedomestic U.S. markets are. The safest statement to make is, perhaps, thatwith EMU the domestic ‘‘monetary habitats’’ of the dollar and the euroare of comparable size and both larger than that of the yen.

The present paper deals with the external use of the future three major

1 Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxemburg, Netherlands,Portugal, Spain.

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currencies. More precisely, it is about their use in the invoicing of foreigntrade, i.e., as a foreign trade vehicle currency. The concept of trade vehicleuse in the narrow sense relates to the case where the two counterpartiesinvolved in an international trade transaction decide to use a third currencyto denominate and settle their trade contract, while in the broad sense theconcept also includes the case where one of the two home currencies isemployed as the medium of exchange. While before EMU the dollar wasclearly the most important trade vehicle currency—and in the narrow sensevirtually the only one—the question arises whether the substantial role ofEuropean Union countries in world trade (Table I) implies that the eurowill catch up in the future. Another question is whether the Japanese yenwill remain a relatively unimportant trade vehicle currency or gain at leasta more important regional role within Asia.

In order to address these issues I briefly describe in the next section themost up to date data on aggregate world trade invoicing currently available,as gathered in the early 1990s by a study group chaired by Niels Thygesen(ECU Institute, 1995), and explain the ‘‘simple arithmetics’’ of EMU, thereshuffling of currency shares through the merger of a number of importantnational currencies. This first simulation gives an estimate of the roles ofdollar, yen, and euro in trade invoicing, if all trade contracts formerlyinvoiced in an EMU member country currency would simply be convertedinto euro, without any behavioral changes. The following section reviewsbehavioral theories of foreign trade invoicing and stylized facts establishedin the empirical literature. Although the theoretical literature of foreigntrade invoicing is not very well developed, there are a few theoreticalhypotheses and some relatively well-established empirical regularities,which can be used as a basis for a simple scenario analysis. Section 4 thendiscusses various scenarios of potential behavioral changes in internationaltrade invoicing through EMU on the basis of historical data on trade flowsand inflation rates, in particular in which direction the evolution of intra-and interregional trade flows will drive global trade invoicing shares andwhether commodity prices, in particular oil prices, may start to be invoicedin euro instead of dollars. Section 5 concludes with some more far-reachingconsiderations about international currency competition after EMU.

2. THE ‘‘SIMPLE ARITHMETICS’’ OF EMU: A SNAPSHOT OFINTERNATIONAL TRADE INVOICING ON DAY ONE

In a first step to determine the future roles of the three major currenciesin trade invoicing one can compute potential dollar, yen, and euro use onthe basis of historical data on invoicing practices and international tradeflows. A useful data set of invoicing practices in seven industrial countries


and OPEC has been recently collected by the European Commission andpublished by a study group of the ECU Institute (1995). Although estima-tions of invoicing practices outside these seven countries rely on somedrastic simplifications, this source together with statistics specifying regionalbreakdowns of international trade flows (United Nations, 1995) can beused to make some predictions about approximate invoicing currency useafter EMU.2 The results and how they are reached are summarized inTable II.3

The left-hand side of the table shows the importance of the major curren-cies in export invoicing in 1992, as reported by the ECU Institute (1995).4

The dollar (USD) remains the clearly dominant currency in internationaltrade, whose share in global invoicing in 1992 still exceeded the UnitedStates’ share in international trade (12.3%) by almost a factor of 4. Thesecond most important currency in international trade is the deutsche mark(DEM). Although slightly up compared to 1980, its share in trade denomina-tion in 1992 was only 4 percentage points higher than Germany’s share inworld exports in the same year (11.8%). This reflects the fact that, in contrastto the U.S. dollar the German mark plays hardly any role as a trade vehiclecurrency in the narrow sense (i.e., for trade contracts where none of thecounterparties is German), not even within Europe.5 Finally, as is now wellknown (see Tavlas, 1992, and Dominguez, 1998) the Japanese yen (JPY)is used very little in global trade invoicing (4.8% in 1992), which is onlyabout half of Japanese exports (9.3%) and even less than the roles of theFrench franc (6.3%) or the British pound (5.7%).

Europe’s currency unification changes this picture. While from a politicalpoint of view intra-European cross-border trade between ‘‘in’’-countries isstill foreign trade, from the point of view of international currency competi-tion intra-European transactions cannot be counted as euro invoicing anymore, because as for the case of trade between Tokyo and Osaka thecurrency of denomination is the ‘‘domestic’’ one, which faces virtually nocompetition within the currency area, be it the United States, Japan, orthe EMU-‘‘in’’ countries in Europe. This effect reduces the absolute amountof euro invoicing below the aggregate of total EU-currency invoicing beforeEMU. To be consistent when deriving post-EMU currency shares, global

2 The details about how invoicing practices in regions for which explicit information wasunavailable has been estimated are given in the background paper by van de Koolwijk (1994).

3 Trade figures reported relate to total merchandise trade. Figures on services trade arerelatively unreliable and very incomplete and the available information on currency invoicingin international trade refers to merchandise trade alone.

4 I am not aware of any more recent and similarly comprehensive source of world tradeinvoicing practices.

5 van de Koolwijk (1994, pp. 55–59) showed this for bilateral trade between France andItaly and argued that this example is quite representative.


TABLE IITrade Invoicing in Major Currencies Before and After EMU

Intra-EU-15 Extra-EU-151980 1987 World 1992 (EU-11) 1992a (EU-11) 1992a

% % bn. USD % bn. USD % bn. USD %b %c

USD 56.1 47.9 1,740.5 47.6 141.1 3.9 1,599.4 43.7 59.4(105.2) (2.9) (55.7)

JPY 2.1 4.0 175.5 4.8 4.3 0.1 171.2 4.7 6.3(3.1) (0.1) (6.0)

DEM 13.6 16.1 559.4 15.3 296.6 8.1 262.8 7.2 9.8(281.8) (7.7) (9.1)

FRF 6.2 6.5 230.4 6.3 116.8 3.2 113.6 3.1 4.2(109.4) (3.0) (4.0)

GBP 6.5 5.5 208.4 5.7 103.0 2.8 105.4 2.9 3.9(3.7)

ITL 2.2 3.2 124.3 3.4 61.9 1.7 62.4 1.7 2.4(58.5) (1.6) (2.2)

NLG 2.6 2.8 102.4 2.8 48.3 1.3 54.1 1.5 2.0(44.8) (1.2) (1.9)

EU-5d 31.1 34.1 1,224.9 33.5 626.6 17.1 598.3 16.4 22.2EU-4e 24.6 28.6 1,016.5 27.8 523.6 14.3 492.9 13.5 18.3

(13.5) (17.2)EU-15 — — — — — — 679.1 16.6 25.2(EU-11) f (541.6) (14.8) (18.8)Exports 100.0 100.0 3,656.1 100.0 963.0 100.0 2,693.1 100.0 100.0(EU-11) (782.6) (2,873.9)

Sources. Pre-EMU invoicing share estimates from ECU Institute (1995), export figuresfrom United Nations Statistical Yearbook (1995), intra- and extra EU invoicing author’s calcu-lations.

a Estimated from national export figures and invoicing practices assuming that all 15 EUcountries join EMU (figures for 11 EMU members, excluding Denmark, Greece, Sweden andUK, in parentheses).

b Percent of pre-EMU world exports.c Percent of post-EMU (‘‘extra-EMU’’) world exports.d France, Germany, Italy, Netherlands, United Kingdom.e Excluding UK.f Euro invoicing resulting from EU currencies not included in rows above estimated from

those countries’ exports to non-EU countries assuming 50% home-currency invoicing: 80.8bn. USD (2.2%/3% of world exports) for EU-15 and 48.7 bn. USD (1.3%/1.7%) for EU-11.

world trade must also be reduced by the amount of intra-EMU zone transac-tions. As a consequence, the relative shares of non-EMU countries in worldtrade denomination automatically rise. I like to think of these two effectsas the ‘‘simple arithmetics of EMU,’’ although they would of course alsoapply to any other currency union with a single currency (Hartmann, 1998b).

On the right-hand side of Table II I present the impact of the ‘‘simple


arithmetics’’ on world trade denomination for two cases: all EU countriesjoining EMU (EU-15) and 11 EU countries joining (EU-11, excludingGreece, Sweden, and the United Kingdom). This implies a ‘‘reduction’’ oftotal world trade by 26% if all EU countries were ‘‘in’’ (last row) and 21%for EU-11. EMU-to-rest-of-the-world (ROW) trade remains unchangedexcept that all trade that was denominated in an EMU currency beforenow switches to the euro. Rows EU-5 and EU-4 report the trade vehiclecurrency uses (erased or remaining) for all EU currencies together forwhich invoicing data are available; in the first case including the UnitedKingdom and in the second case excluding it. Thus, on the right of theserows one finds relatively precise estimates of the future use of the euro ininternational trade in absolute terms, in percent of pre-EMU world tradeand in percent of post-EMU world trade.

It appears that, with UK participation in EMU, a sum amounting to atleast 17% of pre-EMU world exports would be ‘‘lost’’ for euro invoicing,because it is now regional trade. This is about half of the total amount ofEU-currency invoicing and more than the total share of deutsche markinvoicing before EMU. (Without the UK this number reduces to 14%.)Hence, one can infer that from these currencies total euro invoicing willbe 16.4% (13.5%) of pre-EMU world trade or 22.2% (18.3%) of post-EMUworld trade.

These estimates may be imprecise for two reasons. On the one hand,they could understate the likely starting level of the euro in internationaltrade, since the Commission data cover only the five major European Unioncurrencies. A back-of-the-envelope estimation based on the assumption of50% home-currency invoicing of exports from the remaining ten (seven)EU countries results in an additional 80.8 (48.7) bn. USD of euro invoicing(row EU-15 (EU-11) in Table II).6 The main reasons why the inclusion ofthese countries has only a minor impact on future euro invoicing (about2% of world trade) are that, first, their weight in international trade iscomparatively small and, second, the larger part of their trade becomes‘‘domestic’’ trade after EMU. Including them in the estimations impliesthat roughly a quarter of world trade would be invoiced in euro (19% forEU-11), right from the start of EMU. This implies that the total advantageof the euro, compared to the German mark before EMU, would be about10 percentage points for EU-15 and only about 4 percentage points forEU-11. It is also apparent from the results presented that—apart from theEMU core countries and the UK—the fact that a particular country is ‘‘in’’or ‘‘out’’ does not have an important impact on the potential of the euroto become an important international trade vehicle currency.

6 The average of home-currency invoicing for the five EU currencies explicitly reported inTable II is 49.8% of their exports.


The second imprecision in the estimates of Table II originates in the factthat most available data do not contain information on differences betweenintra-EU trade invoicing and EU-to-ROW trade invoicing. Therefore theassumption had to be made that the currency distribution of trade invoicingis the same in both cases. The Deutsche Bundesbank (1991) found it tobe roughly valid for the German case, although it might still lead to anoverestimation of EU-external home-currency invoicing for other coun-tries.7 However, it is difficult to correct for this with any degree of precision.8

Concerning the impact of EMU on non-European currencies, absolutedollar invoicing will diminish, while the change for the Japanese yen isnegligible (Table II). This is due to the fact that the dollar still plays somerole as a trade vehicle currency (in the narrow sense) within Europe (forexample for some oil trade (McCauley, 1997)) and the yen does not playany such role at all.9 Nonetheless, the dollar will be able to maintain itsdominant role in international trade directly after completion of EMU. ForEU-15 a fraction of 44% of pre-EMU trade and 59% of post-EMU tradeshould be denominated in the U.S. currency. (For EU-11 the latter figuredeclines to 56%.) This is more than twice as much as the likely initial levelfor the euro.

3. STYLIZED FACTS OF TRADE INVOICING BEHAVIOR ANDTHEORETICAL EXPLANATIONS

The previous section has drawn a completely static picture of ‘‘arithmeticeffects’’ EMU will have on the global distribution of invoicing currencies.In order to study dynamic effects of EMU and contemporaneous eventsin the international monetary system, I first review briefly in this sectionthe current empirical and theoretical knowledge about the choice of foreigntrade vehicle currencies. These insights can be used in the next section to

7 The difference between mark invoicing of German exports to non-European countriesand to European countries is very small (Deutsche Bundesbank, 1991, pp. 41f.). The reasonis that mark invoicing of Germany’s trade with the United States is lower than the average,whereas mark invoicing with most other non-EU countries (in particular with developingcountries) is much higher than the average. Nevertheless, this home currency invoicing patternmight still be different for other EU countries.

8 An attempt to correct for it has been undertaken in Hartmann (1996, Table IV), whichled to a downward revision of global euro invoicing by 1 percentage point. For the purposeof the present paper I shall assume that the German case roughly carries over to otherEU countries.

9 However, the reduction of total dollar invoicing by about 4% of world trade for EU-15reported in Table II (3% for EU-11) might be a little bit too high, due to the assumptionthat the currency distribution of European trade invoicing is the same for EU-internal andfor EU-external trade.


draw some inferences about the evolution of euro, dollar, and yen use ininternational trade invoicing after the introduction of the single Euro-pean currency.

3.1. Stylized Facts

A number of regularities have been observed in the choice of currenciesfor the invoicing of international trade (Grassman, 1973; Page, 1977, 1981;Scharrer, 1981; Black, 1990; Tavlas, 1991; van de Koolwijk, 1994; previ-ous section).

(1) For trade in manufactured goods between industrial countriesthe major part of contracts are denominated in the exporter’s currency andmost of the remaining contracts are denominated in the importer’s currency,while third-currency invoicing is relatively rare (‘‘Grassman’s Law’’).10

(2) For trade between industrial and developing countries the indus-trial country’s currency or a third currency (usually the U.S. dollar) is usedin most cases.

(3) The U.S. dollar is the only currency for which the share of foreigntrade invoiced in that currency substantially exceeds the share of the respec-tive country in world trade. German mark invoicing is important withinEurope, but invoicing in mark only slightly exceeds Germany’s trade share.

(4) Inflationary currencies are used less in their country’s foreigntrade than less inflationary currencies.

(5) Trade in primary products is usually invoiced in dollars (andhardly in sterling any more).

This list suggests that the invoice currency decision is mainly related tohome currency preference, the type of good and country considered, per-haps also to the counterparties’ sizes (bargaining power) and sophistication,to monetary stability and incumbency.

3.2. Theoretical Explanations

Most attempts to explain these facts in a more rigorous fashion adoptthe perspective of individual firms’ optimal currency choice in the face ofprice and exchange rate risk, focusing on exporters’ home currency prefer-ence (stylized fact 1, Grassman’s Law). Bilson (1983) developed a modelof bilateral bargaining between an importer and an exporter over priceand invoicing practice, which highlights incentives for exporters and import-ers to seek or accept invoicing in the exporter’s currency. If the importer’sprice risk in the domestic market is more highly correlated with the ex-change rate (through approximations of PPP) than the exporter’s cost risk,

10 Grassman’s Law highlights the home-currency preference in international trade. However,there are some important exceptions to it, e.g., Finland or Japan.


then the former will have a natural hedge when accepting invoicing in thelatter’s currency, which would explain Grassman’s Law. This asymmetryin ‘‘exchange risk hedging’’ can be justified with the evidence that importers’exposures to exchange rate risk seems to be clearly longer than exporters’exposures to it (Magee, 1974). In this model a high variability of the domes-tic inflation rate also increases the incentive for any side to accept theother’s currency (stylized fact 4).11

In opposition to Bilson, Viaene and de Vries (1992) derived the domi-nance of invoicing in the exporters’ currencies’ from a bilateral bargainingmodel with random matching of exporters and importers, with completeforward cover but without referral to PPP. Based on the observation thatimport companies usually outnumber export companies, they infer thathigher bargaining power of the exporters should lead to more invoicing intheir currencies.

McKinnon (1979) introduced conceptually the distinction between tradeinvoicing in strongly differentiated manufacturing goods (tradables I, suchas cars) and relatively homogenous primary goods (tradables II, such as oil).While in McKinnon’s view each international trader’s ‘‘preferred monetaryhabitat’’ should in general be his home currency, no more than one partycan get her will. In the case of tradables I the producers (exporters) havesome market power to keep prices fixed. Demand shocks can be absorbedwith inventory changes at constant sales prices. This ‘‘pricing to the market’’policy can be completed with international trade denomination in the ex-porter’s home currency. If most inputs are paid in local currency as well,the exporter can in this way eliminate additional price risk from exchangerate fluctuations (stylized fact 1). In the case of tradables II single producersare rather price takers and efficiency gains in price comparisons for custom-ers leads to a tendency to quote (and settle) in a single international currency(stylized fact 5).12

Another factor influencing foreign traders’ invoicing decisions are mone-tary network externalities (or ‘‘thick-market’’ externalities). Additional usersof a medium of exchange increase the utility of its incumbent users, because

11 Earlier attempts to explain these relationships are Baron (1976) and Cornell (1980). Raoand Magee (1980) established an irrelevance proposition in foreign trade invoicing. Theyargued that in equilibrium trade prices should incorporate exchange risk premia because ofthe absence of arbitrage possibilities between goods and bond markets together with coveredinterest rate parity. Risk neutral agents should therefore be indifferent with respect to currencyinvoicing and differences in invoicing behavior (in equilibrium) can only reflect differencesin attitudes toward risk. While this result and the assumptions about arbitrage possibilitiesbetween asset and goods markets on which it relies are controversial (Goeltz, 1980), it is partof a general debate about the validity of simple ‘‘laws’’ of trade invoicing regularities (Carseet al., 1980; Basevi et al., 1987).

12 See Carse and Wood (1979), Magee and Rao (1980), and Tavlas (1991) for refinementsand more detailed discussions.


the latters’ transaction costs diminish. These network externalities implysome circularity in the use of exchange media and, ceteris paribus, a certaintendency toward concentration. They can also be responsible for an impor-tant degree of inertia in the use of exchange media; once a medium isestablished and expectations have become consistent with equilibrium, itbecomes all the more difficult for another medium to take its place.

In the case of international trade denomination exporters and importerswill agree on a currency for invoicing and settlement, which can be bought,sold, or hedged at low transaction costs in the foreign exchange market orwhich has a relatively high degree of acceptability for other transactions.Foreign exchange transaction costs (including potential hedging costs) andacceptability for other transactions can also explain the wide-spread home-currency preference in international trade (stylized fact 1). The latter aspectis also emphasized in the monetary random-matching model of Matsuyamaet al. (1993), in which a domestic and a foreign agent are assumed tomeet with lower likelihood than two domestic agents. If there is no home-currency preference, because for example the local currency is very smallor unstable, an already important international currency with a deep andbroad foreign exchange market and a high degree of international accept-ability will be preferred to other ‘‘third’’ currencies (stylized facts 2, 4, and5). The determinants of transaction costs in the foreign exchange marketare discussed in great length in Hartmann (1998a,b,c). In the long run, themost widely traded currencies (with the highest transaction volumes) have,ceteris paribus, the lowest transaction costs. However, exchange rate volatil-ity increases transaction costs, countering very volatile currencies’ use inthe denomination of international trade.

4. THE EVOLUTION OF DOLLAR, YEN, AND EUROINVOICING IN THE NEXT MILLENNIUM

The numbers for dollar, yen, and euro invoicing found in the last columnof Table II have to be interpreted as estimates of their starting level oncethe new monetary regime in Europe is implemented. Referring to thestylized facts and theoretical explanations in the previous section, monetarynetwork effects, regional developments in developing country trade, pro-spective inflation performances, and aggregate commodity demands mayindicate more about the evolution of international trade vehicle use afterthe original switch.

4.1. Size Effects and Grassman’s Law

Starting with network effects, given the comparable sizes of the U.S. andEU-15 (EU-11) economies and Europe’s larger share in international tradethan, say Germany’s, (Table I) it is quite likely that invoicing in domestic


TABLE IIIScenarios of Euro Invoicing after EMU

Euro invoicing in external Euro invoicing in world exportsEU-15 (EU-11) exports for EU-15 (EU-11)a

Scenarios ofinvoicing shares % of EU exports bn. USD bn. USD % of world exports

Like USA 92 566 (460) 890 (713) 33 (25)Like Germany 77 474 (385) 800 (638) 30 (22)Like EU-15b 58 356 (289) 679 (542) 25 (19)Like France 55 339 (275) 663 (528) 25 (18)

Sources. See Table II, author’s calculations.a,b Euro invoicing in external EU exports (estimated from national invoicing figures to be

355.5 bn. USD for EU-15 and 288.8 bn. USD for EU-11) plus euro invoicing in the rest ofthe world (estimated as the differential between the former and global EMU-external invoicingshares in Table II (679.1/541.6 bn. USD): 323.6 bn. USD for EU-15 and 252.8 for EU-11).Shares in percent of post-EMU world trade.

currency of EU exports reaches a higher level than the case so far. TableIII compares four scenarios of euro invoicing in EU-15 (EU-11) exports,which are reported in descending order of euro use. The most expansionaryscenario assumes that 92% of member countries’ exports after EMU willbe denominated in euro, which is the share of dollar invoicing in U.S. exports(ECU Institute, 1995). The most ‘‘contractionary’’ scenario hypothesizes ashare of 55% euro invoicing, corresponding to the fraction of franc invoicingin French trade. The other two cases correspond to the effective exportEU-currency invoicing shares reflected in Table II (58%) as a baselineand to the mark-invoicing share in German exports (77%). Under thesescenarios total EU-15 euro invoicing will be between 25 and 33% of (post-EMU) world trade. EU-11 euro invoicing would lie between 18 and 25%.Provided that the European Central Bank pursues a stability-oriented mon-etary policy, it may be expected that in the rest of Europe home-currencyinvoicing increases over time to the level of mark invoicing in Germanexports, which would raise euro invoicing from the baseline of 25% (19%)to 30% (22%) of world trade. Should the U.S. level be reached later on,the euro share could even climb to 33% (25%).

In the previous section evidence was cited showing that trade in manufac-tured goods among industrial countries is mainly denominated in the export-er’s currency. Hence by extrapolation of trends in manufactured goodstrade among these countries it may be possible to say more about theevolution of the future rivalry between the euro, the dollar, and the yen.Table IV summarizes the relevant developments in the 1980s and early1990s. It shows that manufactured trade among industrial countries (ad-


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justed for intra-EU trade) rose by a cumulative 142% between 1980 and1993. While Japan’s trade grew overproportionally (208%), the UnitedStates lagged behind, by less than the EU though. Looking at the averageannual growth rates it appears that (lately) the United States has expandedmanufactured trade quicker than the EU or Japan. Which impact do thedifferent regional growth rates have on the respective shares in total intra-industrial-county manufactured goods trade? Since 1980 the EU’s shareseems to be slightly down, from 32 to 29%, while Japan’s share rose from16 to 21%. In more recent times (between 1988 and 1993) no importantchanges in the regional decomposition of trade among these countriesoccurred. Taken together these figures do not indicate important trendsfavoring any of the three main currencies.13

4.2. Regional Developments in Developing Countries’ Trade

In Table V I use the same measures as in Table IV in order to analyzethe development of trade flows from industrial countries to developingcountries. Based on stylized fact 2, cited at the beginning of the previoussection, an increase in an industrial country’s market share of exports todeveloping countries implies an increase in that country’s domestic curren-cy’s use in international trade. The table shows, again, that Japan’s exportsexpanded most, while the EU’s trade growth to developing countries wasrelatively low, both in the long and in the short run. Concerning marketshare the EU has lost about 8 percentage points since 1980, while Japanhas gained more than 6 percentage points. However, in the last couple ofyears, again, no important trends can be observed favoring any of the threelarge currencies over the others. (Notice that Table V did not includeCentral and Eastern European countries in the ‘‘developing country’’ cate-gory, which will be considered separately in Table IX below.)

From the previous tables it appeared that trade shares usually changevery slowly and, thus does the currency distribution of world trade invoicing.In particular, there do not seem to be important trends in the recent paston the global level. This is not very surprising, given the fact that for sometime intraregional trade in the three large blocks, Western Hemisphere,Europe, and Asia, tends to grow quicker than interregional trade. TableVI shows the intraregional trade developments of the four main regionsof developing and transition countries compared to that of total worldtrade. The largest and fastest growing trade region of these is Asia, account-ing lately for about 12% of world trade. Given the strong position of theU.S. dollar as a trade vehicle currency in the narrow sense in this region,it acted as a strong supporter of the U.S. currency’s role in total world

13 The share of manufactured goods trade in total merchandise trade was increasing overthe period considered in Table IV.


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trade. Of course, the recently starting contraction of intra-Asian tradethrough the current crisis goes in the opposite direction.

The other three regions are very small and unlikely to cause dramaticchanges in global trade invoicing. However, Latin American trade hasgrown slowly but steadily in the past few years also providing some supportfor the dollar. (A spillover of the Asian and Russian crises to this regioncould, however, also choke this growth.) Central and Eastern Europeantrade has broken down as a consequence of the fall of Communism at theturn of the decade. While the decline in intraregional trade has stoppedby the end of the sample period, the current Russian crisis may well preventthat it starts growing again in the near future. Notice that this region hadonce accounted for about 4% of world trade. If it should recover this sharesome time in the future it may give a boost to the euro, because the EUexpands its trade with this region faster than the United States (see below,Table IX). Intra-African trade, although growing faster than total worldtrade, is much too small to make any noticeable impact on the global level.

Depending on how industrial countries’ trade links with these regionsevolve their respective currencies’ may gain through network externalityeffects more influence in the denomination of their intraregional trade.Therefore, I turn now to interregional trade. Of particular importance, thecurrent crisis notwithstanding, is of course the ‘‘battle for Asia.’’ In TableVII I show the development of EU, U.S., and Japanese exports with thisregion (excluding the Middle East and, hence, the major oil-exportingcountries). In contrast to what one might have expected from the currentdiscussions about the lack of competitiveness of countries from the ‘‘oldcontinent,’’ EU exports to Asia grew much quicker than those originatingin the United States, and the EU’s trade share has risen slowly but steadilyfrom about 21% in 1980 to about 25% in 1993 (mainly at the expense ofthe United States).14 Given the still continuing weakness of the Japaneseyen as a foreign trade vehicle currency, a continuation of these trendswould imply a growing role for the euro together with a reduction of thedollar’s dominance in Asia. On the other hand, Japan’s trade links with itsneighbors are rising at a similar—or more recently even quicker—pace,which may well raise the profile of its currency in this region. Providedthat the current Japanese and Asian crises can be overcome, new exchangerate arrangements with a stronger role for the yen could further strengthensuch a development.15

In trade with Latin America (Table VIII) the United States is clearly

14 However, it is not excluded that this trend in merchandise trade could be somewhatoffset by a reverse trend in services trade.

15 For discussions of exchange rate arrangements in Asia, see Frankel (1993), Frankel andWei (1994), Kwan (1994), Williamson (1996), Benassy (1997), and Kawai and Akiyama (1998).


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dominant and the dollar is the major vehicle currency. EU shares are notexpanding and Japan’s share does only very slightly. Although the U.S.share has not further increased in the recent past, there is little doubt thatthe euro or the yen do not have much scope to gain market share inthis region.

However, this is different for Central and Eastern Europe (Table IX),where pronounced trends are visible. EU exports to this region grew quickerthan those of the United States. Japanese exports even strongly contracted.Therefore the EU accounts for an ever larger share of industrial-countryexports to these countries, implying a growing role for the euro in inter-regional trade and much scope for it to develop a vehicle currency role inthe narrow sense in these countries’ intraregional trade. If this trade couldreturn some time in the future to the levels observed before the overthrowof communism, the euro could extend its share in world trade invoicing byseveral percentage points.

In contrast, Europe’s export share to the whole of Africa tended todecline recently to some small advantages for the United States and Japan(Table X). However, still almost two thirds of the continent’s imports fromdeveloped countries originate in Europe and its trade in the world total isso small that these developments hardly matter for global invoicing shares.16

As can be expected from ‘‘gravitation’’ theories of international trade, theEuropean Union is also accounting for a major part of the trade of thegroup of Southern and Eastern Mediterranean countries. Chauffour andStemitsiotis (1998), however, reported that in spite of even some markvehicle currency use in the narrow sense in these countries’ trade withEurope, overall EU currency invoicing is still relatively low compared toU.S. dollar invoicing, for example.17 This might change after EMU via thesize effect discussed in subsection 4.1 above.

4.3. ‘‘G-3’’ Inflation Performances

The theoretical discussion in the previous section underlined anotherfactor in trade invoicing practices, domestic inflation rates and variabilities(stylized fact 3). Low inflation is sometimes described as a necessary condi-tion for a currency to become international, which alone is normally notsufficient. Whether the euro becomes more attractive than the dollar orthe yen on this level very much depends on the future monetary policyconducted by the European Central Bank. Assuming that U.S. and Japanese

16 Notice that trade invoicing in French francs vis-a-vis the African CFA (CommunauteFinanciere de l’Afrique) franc zone, which can be expected to switch to euro from January1999, has been included in the simple simulation of Section 2 (Table II). See Hadjimichael andGaly (1997) for a discussion of the trade links between the franc zone and the European Union.

17 These countries are Algeria, Cyprus, Egypt, Israel, Jordan, Lebanon, Malta, Morocco,the Palestinian Authority, Syria, Tunesia, and Turkey.


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monetary policies remain unchanged, the ECB establishing an inflationrecord like that of the German Bundesbank in the past may foster euroinvoicing in international trade, although given low inflation in the recentpast in practically all industrial countries the potential impact may be lim-ited. If the ECB would rather conduct a monetary policy which is someaverage of historical policies in the EU, then the euro could become lessattractive than the dollar in terms of price stability.

Table XI summarizes the monthly inflation histories of the United States,Japan, Germany, and the European Union between 1980 and 1996. EU-7,EU-10, and EU-14 averages are calculated as both unweighted andPPP-GDP weighted averages. In fact, during most periods over the sampleGermany had a lower inflation rate and variability than the United States.Given the substantial convergence of inflation rates in the EU, it seemsplausible that the ECB will be able to match this record relatively closely.Since the mid-1980s, even EU-10 average inflation rates and variabilitiesare similar or even lower than the U.S. equivalents.18 Although the Bankof Japan has produced an extremely low inflation rate during the 1990scompared to the United States or Germany, Japanese inflation traditionallytends to be more volatile than that of its two competitors, which makesthe yen less attractive as a trade invoicing currency. Although this phenome-non of Japanese inflation has diminished over the years, from the data athand it still remains present in the mid-1990s.19

One factor in the future performance of the ECB is the fundamentalapproach to monetary policy taken. Masson and Turtelboom (1997) simu-lated potential post-EMU volatilities in several macroeconomic variables,using the IMF’s multicountry model MULTIMOD, depending on whetherthe ECB pursues monetary or inflation targeting. Whereas, in these simula-tions, inflation targeting resulted in a lower variability of short-term interestrates and the dollar/euro exchange rate than monetary (M3) targeting,inflation varability was only lower for contemporaneous (same year) infla-tion targeting, not for forward-looking (next year) inflation targeting. Fromthat perspective contemporaneous inflation targeting would be the optionmost beneficial for euro internationalization through trade invoicing. An-other factor is the independence and price stability orientation of the ECB,as determined by its Statute (European Council, 1992). This element clearlyhints to low inflation and, therefore, a high attractiveness of the euro forinternational traders. The political decision about the composition of theECB’s governing council and the popular acceptance of ECB policies in

18 However, the low EU-10 inflation variabilities may, in part, be an artificial effect of theaveraging procedure.

19 This is in contrast to Tavlas (1992, Table 2), who argued that the phenomenon hasdisappeared for quarterly consumer price inflation (CPI) rates.


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EMU countries, two more factors, cannot be judged more than half a yearbefore the decision on EMU member countries has been taken.

4.4. Commodities Pricing and Derivatives Trading

Invoicing regularity number 5 stipulated that trade in primary productsis to a large extent priced in U.S. dollars. An argument which has beenbrought forward is that if all EMU members together aggregate to a largerimporter of certain homogenous goods than the United States or Japan,then the euro could replace the dollar for these goods. This, in turn, wouldgive commodity exporting (developing) countries incentives to start invoic-ing part of their exports in euros as well (Kenen, 1995).

The most important commodity is, of course, oil. According to data ofthe World Trade Organization (WTO, 1996, Tables IV.13 through IV.17),world fuels exports amounted to 349 bn. USD in 1995 or 6.9% of totalmerchandise trade. Deducting 57.8 bn. USD of fuels trade between WesternEuropean (and 15.6 bn. USD between Northern American) countriesamounts to a post-EMU share of roughly 8.0%. Western Europe has thelargest share of fuels imports from the rest of the world (outside Europe)indeed, amounting to 26.6% of the total. North America (imports fromoutside the region) and Japan follow with shares of 19.3 and 19.6%. (TheU.S. share alone would be 21.6%.) From these data expectations that theeuro has a chance to replace the dollar as the main invoicing currency forfuels can be confirmed.

However, there are some more considerations necessary than to simplycompare global demand shares. First, potential distortions through devia-tions of market exchange rates from equilibrium levels have to be kept inmind (remember from the discussion of Table II that current exchangerates seem to ‘‘favor’’ European trade shares). Second, there are regionaldifferences. Europe receives about the same quantities of fuels from Africaas North America receives from Latin America and gets most of the restfrom Central and Eastern European countries. The main importer fromthe Middle East is Japan (leading the EU and the United States), whichimports most of the rest it needs from Asia. Intra-Asian fuels trade aloneaccounts for roughly 16% of the world total. Given that Middle Eastern,Latin American, and Asian countries clearly had a preference for the dollarup to now, the euro might have a difficult start. Third, McCauley (1997)pointed out that for many countries commodity prices in dollars are cur-rently less volatile than they would be in deutsche marks. Fourth, at presentthe main derivatives markets for these products are in the UK and in theUnited States, and they function mainly in dollars, which will further en-hance the network advantages of the U.S. currency, in particular if the UKshould stay out of EMU. These three arguments point to potential inertia


in commodities invoicing which may favor incumbency, the dollar, overglobal demand share, the euro, for quite a while.

An event which could make a difference though, would be EMU member-ship of the UK. This would shift the London commodity markets (Interna-tional Petroleum Exchange, London Bullion Market, London Metal Ex-change, etc.), which in some cases even lead U.S. markets, to the euro,improving the situation for the European currency. Given the regionaldifferences in commodities demand described above, one potential scenariocould be a split of commodities pricing in a dollar zone, with derivativesmarkets located in, say, Chicago, and a euro zone, with derivatives marketslocated in London. With 8% of post-EMU world trade being fuels tradeand about 4% other primary goods trade there would be some potentialfor the euro to close part of the gap to the dollar described in Table IIabove.

5. SUMMARY AND CONCLUSIONS

The present paper discussed various scenarios for the evolution of thedollar, the yen, and the euro, the future single European money, as foreigntrade vehicle currencies. It turned out that the simple conversion of currentEU-15 (EU-11) invoicing practices from national moneys to the euro andthe related removal of intra-EMU merchandise trade from global ‘‘foreign’’trade would result in post-EMU starting levels of 59% (56%) of world tradefor the U.S. dollar, 6% (6%) for the Japanese yen and 25% (19%) forthe euro. The paper further surveyed some now well-known stylized factsregarding the choice of currency in international trade denomination andtheir theoretical explanations. The insights gained were then used to discussvarious scenarios for the evolution of those shares after the changeover.

It was argued that monetary network externalities would lead to a gradualincrease of home-currency invoicing in EU-15 (EU-11) to ROW exports,which could raise the euro’s share in global trade from 25 to 30% (from19 to 22%). If euro invoicing in EU-15 (EU-11) exports would reach thelevel of dollar invoicing in U.S. exports, according to the data at hand, thisnumber could even increase to 33% (25%). From a study of regional tradeflows it appears that the euro will gain further market share mainly in tradewith (or of) non-EMU Western European countries, Central and EasternEuropean countries, Mediterranean countries, and, perhaps, Asian coun-tries. While most of the euro’s growth in these regions would be at theexpense of the dollar, the U.S. currency is likely to maintain its strictdominance in the Western Hemisphere. If Japan can overcome its formida-ble domestic problems and if new exchange arrangements with a larger


role for the yen are put in place in the aftermath of the Asian crisis, theJapanese currency could improve its weak role as a trade vehicle currencyin Asia. However, for the current times of crisis this is unlikely tohappen.

With a view on the statute of the European System of Central Banks,which established price stability as the primary objective of monetary policy,and on past inflation experiences of various aggregates of EU inflationrates and variabilities, it emerges that the euro is most likely to closelymatch the stability of the deutsche mark before EMU, which can be seenas a necessary condition for its internationalization. Lately, the U.S. inflationrecord is not very different from the mark either. However, while yeninflation is now extremely low for a number of years, monthly inflationvariability in Japan remains an obstacle to trade invoicing in yen. Finally,Europe is the largest importer of fuels in the world, although most of itcomes from Africa and Eastern Europe. The United States is the biggerimporter from Latin America and Japan from the Middle East. Given this,it cannot be excluded that Europe’s oil trade with Africa and EasternEurope may switch from dollar to euro some time in the future, while therest of fuels trade remains dollar denominated.

An important development which could foster such a scenario would bethe switch of London commodity exchanges to euro pricing, for examplethrough the UK joining EMU at a later stage. In fact, not only due to itsbroad and deep commodity and general financial markets, but also throughthe pound’s still quite important role in trade invoicing and foreign exchangetrading (Hartmann, 1996), the UK’s membership in EMU is quite an impor-tant factor for the euro to start catching up with the dollar as the majorinternational currency. However, although the euro will immediately leapto number two in the world order of currencies and despite the initial jumpin the ‘‘domestic monetary habitat’’ and all the expansionary potentialenumerated above, I come to the conclusion that the euro’s growth ininternational trade after the changeover is most likely to be gradual, sincedue to heavy EMU-internal trade the external size jump of euro use ismuch more limited than the internal one. As a consequence, it appearslikely that the U.S. dollar—although losing part of its advantage overtime—will maintain its role as the dominant vehicle currency in world tradefor the foreseeable future, whereas the yen will most likely play the roleof the U.S. currency’s and the euro’s junior partner.20

20 As reported in Hartmann (1998b), I come to similar conclusions for most internationalmoney functions beyond foreign trade invoicing. Only in the case of investment currency usecan, in principle, this evolution be quicker. However, euro starting levels might also beparticularly low in international financial market (McCauley, 1997). In contrast to Bergsten(1997) as well as Portes and Rey (1998), I do not expect that international investment alonecan raise the euro to the levels of the dollar (or beyond) in a short period of time.


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