4 Colum. J. Eur. L. 395 (1998)

Patricia Pollard. Senior Economist, Federal Reserve Bank of St. Louis.

The final stage in the creation of the European economic and monetary union (EMU) will entail the replacement of the national currencies of the Member States with a single currency-the euro. This event, which is unparalleled historically, is likely to produce the greatest potential rival to the dollar in international currency markets since the dollar deposed the pound. This paper examines the potential role of the euro as an international currency through an analysis of the functions of an international currency.

Economists define money as anything which serves the following three functions: a unit of account, a store of value and a medium of exchange. To operate as a unit of account, prices must be set in terms of the money. To function as a store of value, the purchasing power of money must not deteriorate over time.’ To function as a medium of exchange, the money must be used for purchasing goods and services. Clearly, an international money must also serve these three functions. For an international currency, one used outside its country of issue, these functions are generally decomposed by sector of use-official and private, as in Table 1.2

A currency serves as an international currency for official purposes if it is used as an official exchange rate peg, if governments and/or central banks hold foreign exchange reserves in this currency, and if it is used as an intervention currency. An international currency for private transactions must function as an invoice currency, financial assets must be denominated in this currency, and it must be used as a vehicle currency through which two other currencies are traded. An international currency may also become a substitute currency for a domestic currency. In this case it serves all three functions: unit of account, store of value and medium of exchange. Generally, a substitute currency is used when high inflation or political instability eliminate the store of value function of the domestic currency.