Sheldon Cooper/SOPA Images/Sipa USA via AP Images
The dollar makes up about 60 percent of foreign currency reserves; the euro about 20 percent.
As we have covered previously at the Prospect, something odd is happening amid the great market instability touched off by Donald Trump’s lunatic tariff announcements. Normally during a chaotic trading situation, anxious financiers run to what has long been the safest of investments: dollars and dollar assets, like U.S. government debt. That drives the value of the dollar up and the interest rate on debt down.
Instead, we are seeing the opposite: The dollar is falling against other currencies, and interest rates on American debt are increasing. As yet, these movements are relatively modest, and may represent nothing more than chaos in the market. However, they do indicate a likely weakening of confidence in the stability and security of the dollar as a global reserve currency—which given Trump’s deranged behavior, ought to be expected. A country that elected a senile criminal madman twice is not to be trusted.
Wit that the European Union just might have a once-in-a-century opportunity to provide that stability and security to governments and investors, and swipe some or all of the dollar’s status. But it won’t happen automatically, and it will require permanently ditching the traditional European allergy to debt and printing money.
A reserve currency, of course, is one that is used to settle international transactions. Today, the dollar makes up about 60 percent of foreign currency reserves; the euro about 20 percent. For years now, various people have predicted the collapse of the dollar, upset by the American addiction to cutting taxes on the rich and the resulting government borrowing. But in fact, this is one reason why the dollar is so useful, and a reason why nothing has replaced it. In order for a currency to be used internationally, it—or assets based on it—must be available in large quantities. Massive borrowing means trillions of dollar assets available around the world in the form of U.S. government bonds.
That is why until now the American government could borrow cheaply despite its enormous debt. But as Michael Pettis and Matthew Klein explain in their book Trade Wars Are Class Wars, this “exorbitant privilege” comes at a heavy cost. Structurally high demand for the dollar pushes up its value relative to other currencies, making American exports less competitive. This was a major factor, in addition to the low wages in the nations to which U.S. corporations offshored their production, behind American deindustrialization in the late 20th century. American elites compounded this problem with the neoliberal vogue for “structural adjustment” programs pushed on developing countries suffering currency crises. American-backed agencies like the IMF and the World Bank would sweep in and demand austerity in exchange for a bailout, causing those countries to accumulate massive dollar hoards to protect themselves—pushing up the exchange rate further.
The vast, probably multitrillion-euro EU rearmament and reinvestment effort currently under way could be financed essentially for free.
Running a reserve currency also comes with responsibilities. During the 2008 financial crisis, and again during the COVID pandemic, the Federal Reserve let central banks in Germany, France, Switzerland, the U.K., Japan, and other nations use its “swap line” facilities, through which they could exchange their currencies for dollars—essentially granting them access to the dollar printing press, at a modest price. Close U.S. allies could thereby rely on the dollar, knowing that if a general crisis struck, the Fed would serve as a global lender of last resort, and stave off a general currency crisis.
All that may sound like displacing the dollar is a bad move. Actually, it would come with many benefits, and there are strategies the EU could use if it steps up to position the euro as the reserve currency that could help it avoid damaging its own industrial base. Besides, if the dollar does fall, somebody has to replace it, and better the EU than anyone else.
How to go about it? Silvia Merler outlines the basic idea at Bruegel (an economic think tank based in Belgium). The key strategy would be to issue a lot of EU bonds; rather than individual member countries borrowing, the debt would be backed by the union as a whole. Then, rather than spending the money on tax cuts for the rich as America has done, plow it into the ongoing EU military buildup.
Indeed, the EU has already issued such bonds during the pandemic to the tune of €600 billion, with another €150 billion as part of an EU rearmament program, and demand is high. “On a weighted average, EU bond issuance has been 8.3-times oversubscribed since 2020, and yields remain lower than those paid by most EU members—signaling a structurally strong demand for EU debt,” Merler writes. They would be even more attractive if they were based on some kind of fiscal union (not just the monetary union that currently exists), which could begin with a small tax paid by all countries into a central pot. But a third of the pandemic-era bonds are set to expire soon, more than offsetting the new debt. To replace dollars, many, many more euro-based assets—likely into the trillions—will be needed.
This might even be a wise step for European self-protection. Should a global financial crisis develop, leading to a panicked stampede for anything that seems safe, people will likely buy up any euro cash or euro-based asset they can find, driving its value through the roof.
Additionally, the European Central Bank would be wise to set up its own swap lines, and make them formal and explicit rather than opaque and ad hoc like those at the Fed. This would alleviate anxiety among eligible nations so they don’t have to build up defensive euro hoards and push up the currency’s value, damaging EU exporters.
There would be stiff political obstacles to accomplishing this, of course. Europeans, especially Germans, are historically allergic to borrowing and printing money, much less fiscal union. (That’s one reason why European democracies failed to implement recovery measures like those of the New Deal in the 1930s.) But the potential benefits could be enormous. The vast, probably multitrillion-euro EU rearmament and reinvestment effort currently under way could be financed essentially for free, and the EU would take its rightful place as the leader of the free world.
It took many years for the dollar to get where it is. During the 19th century, the British pound sterling was the reserve currency, and it took the American economy growing far larger than Britain’s, plus two shattering world wars, for the dollar to displace it. Now, Donald Trump may well be doing the work of a century of economic upheaval and Hitlerian destruction in a matter of weeks. But America’s catastrophic self-inflicted loss may be Europe’s gain.
