This content is from: Portfolio
Greek Crisis Doesn’t Erase Euro’s Status as Reserve Currency
Continued central bank diversification will ultimately enhance the currency’s status, assuming no Grexit and an end to QE.

The latest iteration of Greeces debt crisis will likely prove to be a tempest in a teapot in terms of its impact on the euros status as a reserve currency.
The euros importance as a reserve currency has diminished since Europes debt crisis in late 2009. The euros share of global central bank reserves slid to 21 percent at the end of this years first quarter, the lowest level since 2002. The dollars share climbed to 64 percent, from 63 percent at the end of the fourth quarter.
The Greek crisis is part of a regional crisis that has been dragging down the euros appeal, says Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. But I dont think Greece will drag it down further.
Greece and its European creditors continue to work on an agreement to restructure the beleaguered nations debt. One interesting dynamic of Greeces recent crisis is that it didnt depress financial markets beyond the country itself. The euro has stayed above $1.10 for most of the past month.
Financial markets seem to be signaling that the risk for cross-border contagion out of Greece is very low, Kirkegaard says. So I dont expect whats going on in Greece now to have an effect on the euro as a reserve currency.
Investors, including central banks, arent fazed by whats taking place in Greece, which is not surprising, given that its gross domestic product accounts for less than 2 percent of the euro zones total, he says.
From 2002 until the 2008 financial crisis, the euros share of central bank reserves increased, as central bankers sought to diversify from the dollar. And many experts believe that diversification to the euro from the dollar will ultimately resume.
As long as there is quantitative easing by the European Central Bank and uncertainty about Greece, central banks will reduce their euro holdings further, but QE isnt forever, says Athanasios Vamvakidis, head of European G-10 foreign exchange strategy for Bank of America Merrill Lynch. The ECB is scheduled to buy 60 billion euros of bonds a month through September 2016.
Once the ECB reaches its inflation target of just under 2 percent (from 0.3 percent now) and the Greek crisis is resolved, assuming it doesnt involve a messy Greek exit from the euro zone, central banks will begin increasing the euros weighting in their reserves again, he says.
In the long term, we think the euro will lose its reserve currency status only if there is contagion from Greece a full-blown European crisis, says Vamvakidis. And thats not our baseline scenario.
Kirkegaard also thinks use of the euro as a reserve currency will ultimately expand. The currencys share of central bank reserves could rise to 30 percent from the current 21 percent level, he says. Its more a risk managementdiversification issue than anything else, he says.
In the long run, most reserve managers will want to diversify a little bit out of dollars. This reflects the fact that the U.S. is the biggest economy, but not that much bigger, Kirkegaard says. U.S. gross domestic product stands at $17.7 trillion, compared with $13.2 trillion for the euro zone.
It will be difficult for the euro to exceed a 30 percent share in central bank reserves, Kirkegaard says, because of the dollars overwhelming primacy. Theres inertia built into this, he says. So many of the worlds commodities are priced in dollars. Its the currency of choice for project investment around the world. Its really the anchor currency.
Douglas Elliott, an economic studies fellow at Washingtons Brookings Institution, says the euros future attractiveness as a reserve currency probably depends most on the relative attractiveness of the dollar and the Chinese renminbi. The dollar will likely slowly lose share, and the renminbi will gain it, but we dont know the pace at which either will occur, he says. In a study, HSBC predicts that the renminbi will make up 2.9 percent of central bank reserves by year-end.
The dollar should slide in importance because the U.S. share of the global economy falls virtually every year, as emerging markets rise, Elliott says. And the renminbi should rise in importance, because even with Chinas GDP growth slowing to 7 percent, its share of world output and trade continues to climb.
So, whatever reserves that leave the dollar and dont go into the renminbi can go into the euro.
Get more on banking.