The dominant role of the US dollar as an invoicing currency in global trade is well established. Roughly 40% of international trade transactions in goods are invoiced in dollars, a figure well above the US share of global trade of just 10% (Goldberg and Tille 2008, Gopinath 2015, Boz et al. 2020). This dominant-currency paradigm (DCP) differs from the conventional Mundellian assumption of producer-currency pricing (PCP) where trade prices are sticky in the currency of the exporter, as well as from the assumption of local-currency pricing (LCP) where trade prices are sticky in the currency of the importer. The dominant-currency paradigm has important implications for the dynamics of global trade, as it assigns an oversized role to the US dollar exchange rate (Gopinath et al. 2020).
But what drives the use of currencies in international trade? While dominant, the role of the dollar is not exclusive, with more than half of global trade invoiced in other currencies.1 Among these, two are particularly of interest: the euro with a large role in invoicing, and the renminbi with a growing role. In a recent paper (Georgiadis et al. 2021), we assess the underlying drivers. We are especially interested in contrasting the role of economic fundamentals, reflecting strategic complementarities and input-output linkages, with the role of government policies.
The euro and the renminbi are well suited for this analysis. The euro’s role reflects essentially fundamentals, as European officials have remained neutral vis-à-vis its internationalisation and emphasised that it should be determined by market forces.2 By contrast, government policies feature more prominently for the renminbi, as China’s officials have adopted several initiatives to promote its international use, such as the People’s Bank of China’s global network of currency swap lines. In addition to understanding factors that can lead to a growing international role, we consider whether increasing use of the renminbi occurs at the detriment of the US dollar, the euro, or other currencies.
The analysis first assesses invoicing in euros and dollars based on an extended version of the data set compiled by Boz et al. (2020) – the most up-to-date and comprehensive panel data set on trade invoicing currency patterns – which covers 115 countries over 1999-2019. It also uses a subset of the data with information on renminbi invoicing for up to 53 countries.
What fundamentals drive the euro and dollar?
We first explore the role of economic fundamentals using fixed effects panel regressions of countries’ shares of trade invoiced in dollars or euros. We explore both the use of a currency for invoicing of the issuing country’s own trade and of third-country trade. When a country accounts for a large share of another country’s exports, the currency of destination markets is more likely to account for a large share of invoicing. The literature has also stressed strategic complementarities that lead exporters to focus on a few key currencies (Mukhin 2021). These complementarities are expected to matter more for goods that are more homogeneous (Rausch 1999). Finally, integration in global value chains (GVCs) could also lead exporters to invoice in a currency used for imported inputs (Hummels et al. 2001).
We find evidence for these effects. Strategic complementarities in price-setting encourage local currency pricing in trade with large destination markets such as the US and the euro area. The share of exports invoiced in US dollars and euro increase with the share of a country’s exports to the US and the euro area, respectively. The effect is stronger for the dollar, as an additional percentage point in the share of a country’s exports destined to the US (euro area) is associated with an extra 0.8 (0.3) percentage-point in dollar (euro) invoicing.
Strategic complementarities in price setting matter in third-country trade (i.e. transactions that do not involve the US or the euro area) and benefit the US dollar at the expense of the euro. An additional percentage point in the share of a country’s exports in homogeneous goods – for which complementarities in price setting are most pronounced – is associated with an extra 0.2 percentage points in dollar invoicing, against a 0.1 percentage point decline for euro invoicing.
By contrast, integration in global value chains has no impact on invoicing in dollars and tends to boost the use of the euro. However, the impact of global value chain integration on currency invoicing depends significantly on the extent of countries’ integration with the US and the euro area, as measured by the share of total trade accounted for by these destination markets. Figure 1 shows the marginal effect of global value chain integration on export invoicing conditional on the share of a country’s exports destined to the euro area. The blue solid line shows the marginal effect of global value chain integration evaluated at different values of integration in the European value chain, and the grey shaded area shows the 90% confidence bands. The yellow dotted line is the distribution of the shares of exports to the euro area – a proxy for integration in the European value chain – in the sample. Stronger GVC integration is associated with a higher share of invoicing in euro especially for countries more integrated in the European value chain.
Figure 1 Marginal effect estimates of global value chain integration on euro invoicing conditional on imports from the euro area (percentages)
Source: Georgiadis et al. (2021).
Notes: The chart shows estimates of the marginal effect of global value chain integration on export invoicing conditional on exports to the euro area. The blue solid line shows the point estimates evaluated for different values of the share of countries’ imports from the euro area. The grey shaded area shows the 90% confidence bands, while the yellow dotted line shows the estimated density of the shares of imports from the euro area across the sample.
The role of policy
A similar analysis can be undertaken on a narrower sample with information on renminbi invoicing. In addition to fundamentals, we take account of an indicator for swap lines with the People’s Bank of China.
Our estimates suggest that the growing share of China in international trade has primarily led to more use of the US dollar, and to a lower extent of the renminbi, at the expense of local currencies and the euro. Thus, economic fundamentals, with the emergence of China, have eroded the status of the euro but strengthened that of the US dollar. This finding is consistent with the counterfactual analysis based on a quantitative structural multi-country model in Mukhin (2021). He predicts that, due to history-dependence, emergence of a significantly large economy strengthens the incumbent dominant-currency’s position and erodes the status of existing challenger-currencies – as long as there are no shifts in global anchor currency choices and deterioration of the incumbent’s macroeconomic stability.
The pattern is different when considering the impact of policies. We find that the People’s Bank of China’s global network of currency swap lines has contributed to strengthen renminbi invoicing, at least in countries for which China is a large trading partner. This increase has occurred at the expense of both the euro and the US dollar, with the impact on the dollar being more robust. This indicates that, although fundamental factors have been associated with a growing role of the renminbi at the expense of the euro, policy measures explicitly aimed at internationalising the renminbi have weakened the role of both the US dollar and the euro – albeit to a lesser extent.
In terms of policy implications, our findings suggest that preserving the euro area’s openness to trade and the European value chain are important to maintain the euro’s role as an invoicing currency. Also, our findings indicate that China’s global network of currency swap lines is an effective policy measure to overcome frictions that prevent adoption of the renminbi as an invoicing currency.
Authors’ note: The views expressed in this column are those of the authors and do not necessarily reflect those of the ECB or the Eurosystem. They should not be reported as such.
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1 Excluding intra-euro area trade, half of global trade is invoiced in dollars and the remaining half in other currencies, including the euro with a share of about 30%.
2 However, European officials have shown greater openness towards fostering the international role of the euro recently (see Commission 2021).