Interaction Of The Euro And The Euro Area Financial Market Integration

Since its advent, Euro has become a hot spot for research. With the continuous progress of the European financial market integration in recent years, more and more people pay their attention to this problem too. However, the study about their relation is not so much. So, this paper tries to study the relation between Euro and the Euro area financial market integration, focusing on two problems. The first one is the impact of Euro on the Euro area financial market integration. The second one is how the integration of the Euro area financial market in turn affects the role of Euro as an international currency.This paper starts by analyzing if the advent of Euro affects the financial market integration in the Euro area based on factual data. Foreign literatures on this problem usually focus on a specific financial market, but this paper studies the impact of Euro on the integration of four main financial markets (money market, bond market, equity market and retail bank credit market) together and makes a comparison. Based on the indicator system established by foreign scholars for financial market integration and the latest data issued by European Central Bank (ECB), this paper adopts proper price indicators and quantity indicators according to the characteristics of different markets and then scales the impact of Euro on the financial market integration by observing the change of these indicators before and after the advent of Euro. The result shows that the advent of Euro indeed promotes the Euro area financial market integration but the degree of this promotive effect differs across different markets. The effect is most obvious on the unsecured money market, with its cross-country standard deviation of the main interest rates declining to the range of 1-3.5 basis points. In comparison, the effect is weaker on the secured money market. On the bond market, the cross-border holdings of both the government bonds and the corporate bonds show obvious increase because of the birth of Euro. Moreover, the differences between the government bond yields of the main countries in the Euro area and the benchmark yield narrow markedly. However, the explanatory power of the country factor on the country variance of corporate bond yield dose not show the evident decreasing trend. On the equity market the sector dispersion has outweighed the country dispersion under the effect of the Euro, but the"home bias"is still obvious on the cross-border equity trading. The promotive impact of the birth of Euro is least obvious on the retail bank credit market. The country dispersions of the main credit products on this market are still high and the ratio of cross-border retail lending is still below 5%.In order to analyze the reasons for the different degrees of the effect among different markets, we should first find out the internal mechanism through which the advent of Euro affects the financial market integration in the Euro area. It mainly functions through four channels, namely the disappearance of exchange rate risk premium, the adjustment of investment portfolio, the convergence of economic fundamentals and expectations as well as the cancellation of the currency conversion process. Through the analysis, we can find that the most important way of Euro promoting the financial market integration in the Euro area rests with the direct and indirect effect of the disappearance of exchange rate risk and the cancellation of currency conversion process, so the effect is most obvious on the markets where the exchange rate risk and currency conversion cost play an important role.The maturity of the products on the money market is relatively short, the interest rate risk and credit risk are thus relatively low. The exchange rate risk and the currency conversion cost play a very important role among various impediments for integration on the unsecured money market. The advent of Euro eliminated these two factors. With it, the clearing and settlement system has become highly integrated too. Therefore, the advent of Euro has the greatest promotive impact on integration of this market. However, the secured money market involves the different requirements on collateral and various ways of collateral disposal. And it is affected by the segmentation of security market. (Security is generally the most important collateral.) Therefore, the advance of integration on this market because of Euro's birth is smaller than that on the unsecured money market. The exchange rate risk and currency conversion cost are also relatively important on the government bond market, so the advent of Euro greatly improves its integration. However, the market is still not fully integrated because of different credit risk and liquidity of the government bonds issued by different countries. The integration of corporate bond market and equity market is greatly restricted by the differences of legal, tax systems and market practice. The clearing and settlement systems of them are also relatively segmented. So only the disappearances of exchange rate risk and currency conversion cost brought by the advent of Euro play very limited role. Since the traders on the retail bank credit market are relatively small and lacking in relevant professional knowledge, the integration of this market is seriously hindered by the information asymmetry and high cost of cross-border financial trade besides the above-mentioned institutional factors. Moreover,the market is strongly affected by various factors, such as culture, language, trade convenience, macro-economy and financial system, etc. Therefore, the impact of removing the exchange rate risk and currency conversion cost is extremely small.From the analysis above, we can see that monetary integration indeed is helpful for promoting financial market integration, but the promotive effect can only be realized under certain conditions. Monetary integration can not be the substitute for the convergence of legal, tax systems and other basic institutions, the consummation of the financial infrastructure as well as the advance of the whole financial system. The inspiration from this to East Asia is that when the conditions for creating Asor (the single currency of East Asia) are not mature, it should first make great efforts to promote the convergence of legal, tax systems and market practice of different countries, to establish and perfect the integrated financial infrastructure and to improve the whole financial system.The second issue of this paper starts to be illustrated from Chapter 4. First, the author points out the great significance of strengthening the role of Euro as an international currency so as to check and balance the US dollar for resolving the global economic imbalance and relieving the great potential risk of the international financial system. Then the author analyzes the current status of Euro as an international currency in terms of several important functions of currency. We can see that although the international status of Euro was greatly improved, it has not posed substantial threat to the status of USD as the most important international currency. Following is the main part of this chapter, namely the impact of the Euro area financial market integration on the role of Euro as an international currency. First, the author concludes four important factors determining the role of one currency as an international currency from relevant literatures. They are the depth, breadth and openness of the financial market of this currency, the stability of this currency and the confidence in its stability, the economic scale, strength and openness of the issuer of this currency as well as the current international monetary system (money inertia). Then, she analyzes how the Euro area financial market integration affects the international status of Euro through these factors. The Euro area financial market integration can increase the depth, breadth and openness of the financial market, stabilize the value of Euro and improve the confidence in its stability by facilitating the fast, effective and symmetrical transmission of monetary policy, push forward the continuous and stable economic growth and thus expand the economic scale, improve the economic strength and openness. Therefore, it plays a very important role in strengthening the functioning of Euro as an international currency. The current improvement of the international status of Euro is to a large degree determined by the continuous progress of the Euro area financial market integration. At the same time, the difficulties of Euro in competing with USD in many areas are also mainly attributed to the lack of integration in some segments of financial market. Consequently, if we want to further strengthen the role of Euro as an international currency so as to reduce the risk of the international monetary and financial system while the countries in the Euro area share more seigniorage, the key is to promote the Euro area financial market integration. During the process, China should strengthen its cooperation with the European Union, such as more frequently using Euro as the invoicing and settlement currency in bilateral trade and investment,and pay close attention to the return and risk change of Euro-denominated assets and USD-denominated assets so as to make proper adjustments of the reserve.