RPT-BREAKINGVIEWS-Europe can take advantage of King Dollar’s wobble

By Felix Martin

LONDON, April 24 (Reuters Breakingviews) - U.S. President Donald Trump’s volatile economic policies have tanked the dollar and thrown its status as the world’s reserve currency into question. The euro is poised to take advantage. Uncertainty over the transatlantic alliance may finally remove the political obstacles to the all-important creation of a euro zone safe asset to rival U.S. Treasury bonds.

The new U.S. administration has launched an all-out assault on economic orthodoxy, unilaterally declaring a trade war on the rest of the world while clashing with courts and the Federal Reserve. White House adviser Stephen Miran even openly questioned the benefits of the greenback’s status as the global reserve currency.

Shell-shocked investors have responded by deserting the dollar. The main index .DXY of the currency’s strength against those of key trading partners is down roughly a tenth since Trump’s inauguration on January 20, prompting a search for alternatives.

The euro is the only realistic candidate. In the quarter-century since its launch, the single currency’s international reach has consistently failed to match the euro zone’s economic heft. With confidence in American exceptionalism evaporating, however, it is worth casting a fresh eye over what it takes for a currency to go global – and whether this time, the euro might finally make the grade.

To begin with, it’s necessary to grasp that the existence of a single undisputed international currency champion is the historical exception, not the rule. Most of us have never known anything but U.S. dollar supremacy. Yet economic historians Barry Eichengreen and Marc Flandreau have shown that monetary multipolarity is nothing new.

For nearly two decades between World War One and World War Two the UK pound and U.S. dollar constantly jockeyed for first place, judging from their share of global foreign exchange reserves. Sterling lost its lead to the greenback in Britain’s 1920s slump but won it back again following Washington’s devaluation of the dollar in 1933. Before 1914, the German reichsmark was in the mix as well.

Incumbency, inertia, and network effects, it turns out, are less decisive than commonly thought. Instead, there are three critical tests a currency must pass to make it big on the international stage.

The first and most basic is swearing off capital controls. It is impossible for a currency to become the standard denomination for international trade and finance if foreigners cannot freely access it. Both the dollar and the euro clear this low bar easily. Yet China’s renminbi does not, owing to Beijing’s careful management of the exchange rate and capital flows.

The next hurdle, for any aspirant global money, is gaining international circulation. This often gets equated to running a massive current account deficit, as the United States does, since when imports vastly exceed exports it means plenty of a country’s currency is sloshing around the globe, allowing others to accumulate sufficient liquidity.

If true, that would certainly hamstring the euro zone, which has run current account surpluses in all but three of the last 15 years. Yet Britain too was a net exporter throughout sterling’s 19th-century period of global pre-eminence. And when former French President Valery Giscard d’Estaing famously complained of America’s “exorbitant privilege” in 1965, the United States was in the middle of a run of external surpluses that spanned the entire decade.

The reality is that a country can also lend to foreigners, hence putting its currency into circulation via the capital account independently of its trade balance. The true prerequisite for extraterritorial reach is therefore an ambitious and globally active banking sector, backed by a well-resourced and internationally credible central bank. That’s why the dollar only really began to rival the pound after the U.S. Federal Reserve’s founding in 1913.

On this test, the euro zone scores well – if not quite at the American level. The European Central Bank is well established as both a steely guarantor of monetary stability and an agile lender of last resort. Moreover, with total assets worth $34 trillion as of September 2024, the euro zone banking sector was 40% larger than the U.S. one at $23.5 trillion. When it comes to the global share of cross-border lending, however, it is the U.S. dollar that dominates the euro by almost exactly the same margin, according to data from the Bank for International Settlements.

This relative underperformance is explained above all by the third test that a global currency must fulfil, and which the euro fails: the existence of a globally regarded “safe asset” akin to U.S. Treasury bonds. Such an ultimate haven of security is the most fundamental building block of a modern financial system.

It functions as the collateral for repurchase and derivative contracts, the pricing benchmark for all other assets, and the basic savings instrument for domestic and foreign investors alike. Without a like-for-like euro zone substitute, the bloc’s currency simply isn’t at the races. German Bunds are safe, but have historically been too scarce compared with Treasuries.

That fact is not lost on policymakers. In 2011, the European Commission floated the idea of jointly guaranteed stability bonds, which euro zone members would be able to issue in an amount up to 60% of their GDP. The European Systemic Risk Board proposed an alternative plan in 2018 for European sovereign-backed securities or “ESBies”, securitised pools of existing national government bonds, split into safer and riskier tranches. After the pandemic outbreak, the Commission even kicked off an up to 750-billion-euro programme of joint bonds to finance its post-Covid NextGenerationEU Recovery and Resilience Facility – though as a strictly time-limited experiment.

The obstacle to the creation of a euro zone safe asset, however, has always been political rather than technical. Bluntly, the more fiscally conservative members have resisted the principle of joint liability for public debt. Yet in the era of America First, maybe even that shibboleth will fall. Germany has already crossed one fiscal red line with a major debt-funded defence and infrastructure spending programme under incoming Chancellor Friedrich Merz, perhaps suggesting an appetite for bigger change.

Canada shows just how fast public attitudes can change. Trump’s economic and diplomatic blitzkrieg has just produced one of the biggest turnarounds in recent political history. At a stroke, it transformed the incumbent Liberal Party’s trenchant multilateralism from its Achilles’ heel to its strongest selling point. A giant polling deficit has now turned into a narrow lead for the party’s candidate Mark Carney ahead of Monday’s election.

Likewise in the euro zone, the prospect of further financial integration appeared vanishingly slight just a few short weeks ago. Yet with the greatest threat to incumbent parties in both France and Germany coming from the nationalist right, who share some of Trump’s stances, the heightened transatlantic tension may prove a political gift to the dream of a truly global euro.

After all, what self-respecting patriot would now dare to oppose the project that, more than any other, will finally put Europe first?

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