This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 FRANKFURT 001092 
 
SIPDIS 
 
SENSATIVE 
 
STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY FOR DAS LEE 
TREASURY ALSO FOR ICN COX, HULL 
PARIS ALSO FOR OECD 
TREASURY FOR OCC RUTLEDGE, MCMAHON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EUN
SUBJECT: International Use of the Euro - Broadly Stable; 
Some Increase In Euro Trade Invoicing 
 
 
T-IA-F-05-0006 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
¶1.   (SBU) Summary:  The European Central Bank's (ECB) 
  annual publication on the international role of the Euro 
  concludes that the euro's role in international capital and 
  foreign exchange markets and use as an international reserve 
  currency "has remained largely stable," while "there have 
  been signs of increasing use" of the euro for settling or 
  invoicing trade.  This rather unexceptional conclusion, akin 
  to a "dog bites man," story sharply contrasts to the 
  attention-grabbing headlines "Central Banks Shunning 
  Dollar," proclaiming that a survey of central banks revealed 
  many had increased their euro exposure.  The survey, 
  however, was only "impressionistic," in the ECB's assessment 
  and did not provide any hard data documenting any increases. 
 
¶2.   (SBU) Notable features of the ECB's report are that: 
  (a) the Euro's share of official exchange reserves increased 
  slightly, from 19.3% in 2002 to 19.7% in 2003, nearly two- 
  thirds of the increase in euro holdings was due to an 
  increase in the euro's price in relation to special drawing 
  rights (SDRs); (b) the share of exports and imports invoiced 
  or settled in euros has increased in trade with countries 
  outside the euro area; and (c) the euro denominated 
  international debt securities market remains robust, with 
  the stock of euro international debt instruments holding a 
  steady 31% market share.  The ECB's report identifies merger 
  and acquisition activities and firms' strategic objective to 
  broaden their investor base as main reasons for firms, 
  including many from the US, using the euro international 
  bond market. End Summary. 
 
International Role of the Euro 
------------------------------ 
 
¶3.   (SBU) Each year the ECB publishes a report tracking the 
  international use of the euro.  This year's report, 
  published in January 2005, covers the period mid-2003 to mid- 
  ¶2004.  The ECB's policy is not to encourage the use of the 
  euro outside the euro area, but considers developments in 
  the use of the euro as "the outcome of decisions taken by 
  market participants."  The ECB's success in maintaining the 
  value of the euro contributes to market participants' 
  perception of the euro, particularly as a store of value. 
 
¶4.   (SBU) Since its introduction the euro quickly assumed 
  the role of its legacy currencies in finance and trade. 
  With the advent of one currency in the euro area, at a 
  stroke its capital markets were broadened and deepened, at 
  least in theory.  Some accession candidate countries, now 
  the new member states, pegged their currencies to the euro, 
  increased their trade with euro area businesses, and, when 
  the euro cash conversion occurred, saw savers convert their 
  holdings of Deutsche Marks to euro bank accounts.   Earlier 
  ECB reports document this one time shift. 
 
¶5.   (SBU) This year's report suggests that after the first 
  rush of conversions, activity has become less dramatic. 
  Broadly speaking, the report shows a "significant degree of 
  stability" in the use of the euro by non-euro area 
  residents.  There is some evidence that the euro is 
  increasingly being used in settling or invoicing trades with 
  non-euro area countries in neighboring regions, although 
  some of the shift could be an improvement in data collection 
  by national authorities. 
 
International Reserve Currency 
------------------------------ 
 
¶6.   (SBU) Global reserve assets totaled USD 3, 014 billion 
  as of the end of 2003, an increase of 26% from the previous 
  year.  The share of euro-denominated assets of total foreign 
  exchange reserves edged up from 19.3% to 19.7% over this 
  same time period, driven by an increase in euro-denominated 
  holdings in developing/emerging market countries (17.9% to 
  18.9% share).  The share of euro-denominated foreign 
  exchange reserves of industrial countries' total reserve 
  assets declined from 21.3% to 20.9%.  The share of USD 
  denominated foreign exchange reserves rose slightly, from 
  63.5% to 63.8%. 
 
¶7.   (SBU) One interesting feature was the role that price 
  changes played during the recent reporting period.  The 
  International Monetary Fund (IMF) tallies foreign exchange 
  reserves in special drawing rights (SDRs), whose value is 
  derived from a basket of currencies. Therefore, when a 
  currency appreciates against the SDR, the SDR price of 
  assets denominated in that currency also rise.  In 2003 the 
  amount of euros in official holdings of foreign exchange 
  increased by 55 billion SDRs, but 34 billion of the increase 
  was due to a price change.  This reflects the euro 
  appreciation and, according to ECB experts, the large stock 
  of euro-denominated foreign assets being held as reserves. 
 
¶8.   (SBU) The ECB report notes that the amount of USDs in 
  official holdings of foreign exchange increased by 161 
  billion SDRs.  The increase in quantity (263 billion SDRs) 
  more than compensated for the decrease in price (-102 SDRs). 
  This large increase in USD denominated holdings reflects, in 
  part, macro economic strategy by some Asian countries, 
  according to ECB staff, to maintain a stable exchange rate. 
  An October 2004 publication of the New York Federal Reserve 
  Bank surmises, "The largest USD reserve purchases likely 
  came from Japan, China and Taiwan, with India and Korea also 
  making sizable purchases." 
 
¶9.   (SBU) This relatively mundane picture is contrary to 
  the attention-grabbing headlines on January 23 proclaiming 
  that central banks are "shunning the US dollar."  Those 
  headlines were prompted (or promoted?) by a survey conducted 
  by Central Banking Publications.  The survey proclaimed that 
  39 of 65 central banks were raising their euro holdings and 
  29 were reducing their dollar holdings. 
 
¶10.  (SBU) ECB staff, surprised by the report (and summoned 
  to brief ECB President Trichet), examined it carefully.  The 
  survey results were "impressionistic," in their view, based 
  on one question: " Have you increased or decreased exposure 
  to a certain currency?"  The survey did not contain any more 
  recent information or hard data and reflected views of a 
  wide range of banks, from very small to some very large, 
  although the largest Asian central banks did not respond to 
  the questionnaire, in the ECB staff's assessment.  The ECB 
  relies on IMF data to calculate reserves and does not 
  collect its own information from central banks. 
 
Trade :Invoicing and Settling 
----------------------------- 
 
¶11.  (SBU) The ECB report notes that the share of the use of 
  euro to settle or invoice trades for exports and imports 
  outside the euro area has increased, more so for goods than 
  for services.  Most dramatic among the increases has been 
  for Germany, which had 63% of its exports invoiced/settled 
  in euros in 2003 compared to 49% in 2002, and 55% of its 
  imports invoiced/settled in euros in 2003 up from 48% the 
  previous year. 
 
¶12.  (SBU) Germany, France, Italy and Spain all had more 
  than 50% of their exports settled/invoiced in euro while 
  only Germany and Spain had more than 50% of their imports 
  settled in euro. ECB staff observes that this result 
  reflects "Grassman's Law" whereby "exporters are typically 
  in a better position to enforce their currency preferences" 
  than importers.  Of the new member states, the Czech 
  Republic, Estonia, Latvia, Poland and Slovenia all had more 
  than half their exports invoiced/settled in euros (no data 
  for Malta and Slovakia).  Candidate countries Bulgaria and 
  Romania have better than 60% of their exports 
  invoiced/settled in euros. 
¶13.  (SBU) Reasons for the increase are partially due to new 
  data.  The ECB relies on national authorities for this data, 
  some of which has become available only recently.  ECB staff 
  also suspects valuation has contributed to the increase as 
  well as long-term contracts that had been in legacy 
  currencies and are now being renewed in euros.  The ECB 
  report notes that the use of the euro in trade is 
  geographically concentrated in countries neighboring the 
  euro area, but also detects "some evidence" of an increase 
  use in other countries.  There is, however, a natural 
  ceiling to the use of euros in trade, particularly import 
  transactions, as certain commodities that are traded on 
  exchanges or referenced priced in USD, such as oil. 
 
¶14.  (SBU) A recent staff paper of the New York Federal 
  Reserve Bank broadly confirms the ECB's findings.  It states 
  that the USD is "strongly used on all trade transactions 
  with the United States and on other transactions that are 
  primarily in goods that are traded on organized exchanges or 
  that are referenced priced."  The staff paper reports that 
  USD invoicing accounts for more than 50% of exports and 
  imports in the Asian countries of Japan, Korea, Malaysia and 
  Thailand as well as Australia.  Greece was the lone euro 
  area country in this category, most likely due to the 
  predominance of maritime shipping in its trade.  However, 
  the NY Fed paper notes that the share of exports and imports 
  of goods that are traded on organized exchanges or reference 
  priced has declined as trade in manufactures has increased. 
  Thus, the paper concludes that these declines suggest that 
  there has been a steady decline in USD invoicing via this 
  channel. 
 
Debt Securities 
--------------- 
 
¶15.  (SBU) The ECB uses a narrow definition of international 
  securities, referring to issuance in a currency other that 
  the currency of the country in which the borrower resides. 
  Using this measure, the stock of outstanding international 
  debt securities is USD 5,042 billion, 31% of which are 
  denominated in euros, 42% in USDs.  These shares have been 
  steady for the last few years, after the euro legacy 
  currency share climbed quickly after its introduction in 
  1999, gaining nearly 10% in market share by 2001 while the 
  USD share eased 2%.  Using a "global measure" of debt 
  securities that includes securities denominated in the home 
  currency and targets the international and domestic market 
  shows that the USD account for 43% of USD 53,000 billion in 
  outstanding debt securities while the euro accounts for 
  25.6%. 
 
¶16.  (SBU) The ECB explains in another report on the euro 
  bond market reasons for the rapid gains of the issuance of 
  euro denominated international debt securities.  It explains 
  this development as a product of efficiency gains brought 
  about by the growing size of the euro area financial 
  markets, supported by the creation of payment and security 
  settlement systems and a unified money market, as well as 
  increased competition from non-euro area underwriters that 
  drove down underwriting fees. In a special section of this 
  year's report, the ECB analyzes in detail the issuance 
  activity by private entities and concludes that is it often 
  associated with merger and acquisition activity or with the 
  strategic objective of broadening the investor base. 
 
¶17.  (SBU) The largest issuers in this market are European 
  entities, especially UK firms, accounting for 44% of the 
  total in outstanding international debt instruments.  US 
  residents account for about 20% of the issuance activity. 
  Large issuers from the United States include Federal Home 
  Loan Mortgage (Freddie Mac), Merrill Lynch, Goldman Sachs, 
  General Motors Acceptance Corporation and GE Capital. On 
  average, around 80% of these debt issues are initially 
  purchased by European investors. 
 
Foreign Exchange 
---------------- 
 
¶18.  (SBU) According to the 2004 Triennial Survey conducted 
  by the Bank of International Settlements, the euro was 
  involved in 37% of all foreign exchange transactions in 
  2004, a decrease of less that one percentage point compared 
  to its share in 2001.  Average daily turnover in the forex 
  market is estimated to be USD 1,880 billion.   76% of all 
  global activity involving the euro was in trading vis--vis 
  the USD. 
 
Use As Parallel Currency 
------------------------ 
 
 
¶19.  (SBU) Residents in some countries outside the euro area 
  hold assets in euro denominated assets, mostly as cash or 
  euro denominated bank accounts.  In countries neighboring 
  the euro area, foreign cash held in legacy currencies, 
  predominately Deutsche Marks, had been converted into euro 
  cash notes or deposits.  By the end of 2002, two years after 
  the conversion to euro cash notes, the flow of euro 
  banknotes shipped to destinations outside the euro area has 
  stabilized.  Net shipments of euro banknotes to destinations 
  outside the euro area amounted to euro 9.4 billion down from 
  euro 14.2 billion in the previous year.  The cumulative 
  stock of euro banknotes outside the euro area was euro 45.8 
  billion by the end of June 2004 compared to euro 36.4 
  billion a year earlier. 
 
¶20.  (SBU) The ECB's data showed that Russian businesses and 
  households demand euro cash for conducting trade and 
  tourism.  However, when some Russian banks faced liquidity 
  problems in mid-2004, depositors preferred to exchange their 
  ruble deposits into USD cash. 
 
¶21.  (SBU) The nations of the former Yugoslavia have a 
  significant share of bank deposits denominated in euro.  In 
  Croatia, Macedonia, Montenegro and Serbia better than half 
  of the total bank deposits are denominated in euros. 
  Interestingly, the new member states have a much smaller 
  share of euro-denominated deposits with the highest in 
  Latvia, at 19.8%.  This suggests that new member states have 
  more credible monetary policy that protects the value of 
  their local currency.  ECB experts point out that conducting 
  monetary policy is rendered more difficult when a large 
  share of deposits are denominated in foreign currency. 
 
¶22.  (U) This message coordinated with Embassies Berlin, and 
USEU Brussels. 
 
¶23.  (U) POC: James Wallar, Treasury Representative, e-mail 
wallarjg2@state.gov; tel. 49-(69)-7535-2431, fax 49-(69)- 
7535-2238 
 
Bodde