Sharp rise in euro note circulation

According to the ECB's annual report for 2003, the value of euro banknotes in circulation increased by over 20% in 2003 to €436 billion. Almost half of this increase represents demand for the eurosystem's highest value note, the €500. The value of US dollar notes in circulation at the last count (end-May 2004) was $692 billion (€569 billion). By this measure, the euro's bid to challenge the dollar as the world's hoarded currency has truly begun.

The attractions for a central bank of having lots of notes in circulation are obvious. More money issued means more money earned for the central bank (and its government shareholder) from the "seigniorage" revenue generated by the assets backing the note issue. But demand for cash tends to grow in line with the economy and inflation. And cash faces tough competition from debit and credit cards. It is a limited market. One way to expand this though is by exporting high-value notes outside the currency area. These are popular with those who want a "safe haven" for their savings or make transactions which require anonymity. Although the D-mark had some success as an international "hard currency", this market is now dominated by the dollar and the ubiquitous $100 bill or "c-note" - there are nearly half a trillion dollars worth in circulation.

What does a currency need to be attractive? There are three key requirements. It must have the right backing so that it holds its value. It must be a good means of transaction and therefore accepted all over the world. Lastly, high denominations mean you can get more into a suitcase. The euro's highest note, the €500, was worth $502, over five times the highest US note, at the beginning of 2003. By the end of the year it bought you $600.

According to the ECB's annual report, in 2003 the €500 note experienced the biggest increase in demand. The amount in circulation shot up by over 40%. This is in marked contrast to the modest increases of just over 2% for the €5 and €10 notes and 4% for the €20. At a value of €119 billion, €500 notes are now over one-quarter of the euro's circulation by value. The ECB's explanation is that the "increase in demand for euro banknotes is a result of their increased use both as a sore of value and as a parallel currency in countries outside the euro area."

But is the euro starting to challenge the mighty greenback on the world stage - or, more properly, in the world's suitcases? After all what was it Ken Rogoff said a few years ago; "the EMI's decision to issue large notes constitutes an aggressive step towards grabbing a large share of the developing country demand for safe foreign currencies." He estimated the market to be worth $300-400 billion.

In 1996 a Fed study put the amount dollars outside the US at 60% of the total circulation. The ECB estimates that only 9% of total euro banknotes - almost €40 billion- is held abroad, so on this measure the euro still has a long way to go. But a combination of the euro's high denominations and the dollar's recent slide has heightened its appeal. Only two years after first being printed the euro is off to a good start in the battle to be the world's currency of choice, at least for "retail" holders. It is a different story on the reserve currency front, where the dollar holdings of central banks still dominate the field.