The Euro’s Rising Influence

One of the most important events in the foreign exchange market over the last 25 years has been the consolidation of many of the former national currencies of Europe into the single currency of the European Monetary Union that is usually known as the Euro.

The concept of a common currency for a united Europe to simplify transactions among European nations was an idea which had become popular among many corporations and residents of the European community.

At first, various exchange rate regimes were attempted such as the currency snake and the European Exchange Rate Mechanism or ERM. Their eventual failure ultimately led to the development of the Euro which brought the 28 members European trading bloc much closer to having a single currency.

Read our Previous Article: Understanding Reserve Currency

How the European Union was Formed

The EU or European Union has its roots in the European Community or EC founded in Rome in 1957. This led to the signing of the Maastricht Treaty enacted on November 1st, 1993.

In 1995, Austria, Sweden, and Finland joined the European Union, followed by another ten nations in 2004. With Romania and Bulgaria joining in 2007, that brought the total number of member nations in the European Union to 27 countries.

Having a combined population estimated at more than 500 million people, the European Union contributed approximately 28% of the nominal gross world product in 2009, amounting to over 16.5 trillion U.S. Dollars.

The Euro as a Reserve Currency

The Euro was released in Europe as an accounting currency in 1999, and a circulating currency in 2002. Since then, a growing number of national central banks have begun replacing the U.S. Dollar with the Euro as a reserve currency.

A number of reasons behind this situation include the exorbitant U.S. government fiscal spending, seemingly endless wars fought overseas by the U.S. military, worsening U.S. trade and budget deficits and a real estate crisis to top it all off. Overall, these risk factors do not contribute to the safety of the U.S. Dollar as an investment, and central banks are increasingly acknowledging this.

For these and other reasons, the Euro has become the number two reserve currency in the world, accounting for a total of 28% of global currency reserves as of 2009 and significantly increasing its influence.

This is considerably higher than the nearly 18% of the global reserves the Euro made up when the currency was initially introduced in 1999. For comparison purposes, the same ten year time period saw U.S. Dollar reserves drop from 71% to 61% of global currency reserves.

The Euro’s Influence on International Trade Increases

Because of the United States’ status as a trading partner with many nations in the world, the U.S. Dollar has traditionally been held as the reserve currency of choice for many major U.S. trading partners.

Nevertheless, as the further consolidation of the Eurozone progresses, many smaller countries that are non-members with strong commercial ties to European countries are considering pegging their regional currencies to the Euro.

Even so, the U.S. Dollar continues being the primary currency for trading in key commodities such as crude oil and gold. Still, the Euro is increasingly becoming the currency which oil producing nations are favoring over the U.S. Dollar for transactions in oil.

The move to the Euro on oil transactions would further hurt the Dollar’s status in favor of the Euro, and would very likely lead to an even further increase in the Euro’s overall influence in global financial markets.