Economic Report President

advantages of EMU to U.S. residents, as already described. And in anycase the euro is unlikely to rapidly displace the dollar as a major internationalcurrency, given that the foundations of the successful performanceof the U.S. economy remain intact. International currencystatus does not automatically follow from a currency’s possession of alarge home base.The Functions of an International CurrencyWhat does it mean to be a major international currency, and is it likelythat the euro will become one? A currency has three main uses: it canbe used as a means of payment, as a unit of account, and as a store ofvalue. An international currency is simply one that is also used outsideits home country for these three purposes. Within each of the threefunctions, an international currency has both official and private uses.In money’s store-of-value function, investors decide how much oftheir wealth to hold in the form of assets denominated in various currencies.Will public and private investors hold a fraction of their portfoliosin assets denominated in euros? If they hold a fraction thatexceeds the sum of the fractions previously occupied by the Germanmark and the other disappearing European currencies, a portfolio shiftwould occur, leading to greater demand for euros. This, in turn, couldcause an appreciation of the euro. However, whether euro-denominatedassets do acquire a higher share of portfolios will depend on variouseconomic factors. These include the inflation rate in the euro area, confidencein the value of the euro relative to the dollar and the yen, therate of return on euro-denominated assets, and economic growth inEurope, as well as political factors.The official side of the store-of-value use is that central banks holdcurrencies as foreign reserves. The euro’s emergence raises the possibilityof greater diversification of these reserves away from the dollartoward the euro. In the 1970s and 1980s, the dollar’s share of reservecurrency holdings gradually shrank to make room for the mark andthe yen. This trend was suspended, or even reversed, in the 1990s. Butit could resume in the 2000s to make room for the euro. Such diversificationaway from the dollar would depend in part on the same riskrewardconsiderations as matter for private use. Countries with strongeconomic fundamentals, sound currencies, and low inflation are morelikely to have their currency used as an international currency. As longas the United States maintains a strong economy, internationaldemand for dollars will remain strong.A unit of account is a reference scale for quoting prices, which isdistinguishable from the actual currency in which assets are held or paymentsmade. For the private sector an international currency functionsas a unit of account through its use in invoicing imports and exports.Presently, the dollar plays a dominant role in invoicing around the world,especially for primary commodities like oil. Invoicing within Western298