Donald Trump’s egregious comments about Jerome Powell, the Federal Reserve chairman, together with many other recent impulsive actions by the US president, have damaged the standing of the dollar. On that broad question, most economists and commentators on world monetary affairs are in general agreement.
Yet to assess what difference this might make to the way to the way the world’s reserve currency system works, we need to ask a further question. Can the politicians and central bankers behind the world’s number two reserve currency, the euro, turn it into a real contender to dislodge the US, say over the next 10 years, from its position of monetary supremacy?
Whatever happens, Europe will want to avoid hubris. European financial officials with long memories still recall with a shudder a statement by Yves-Thibault de Silguy, France’s enthusiastic commissioner for monetary affairs in the years before the euro’s birth, who said in 1996 that the single currency would be ‘quickly understood in New York and London, sooner than in Paris or Frankfurt, as the tangible sign of re-emerging European power’.
Although China’s economic size makes it a longer-term contender to take the dollar’s throne, the renminbi’s low share of international reserves, plus fundamental political factors, hold back its chances of becoming a serious shorter-term rival.
Figure 1. Euro is the world’s number two reserve currency
Q4 2024, %
Source: International Monetary Fund Currency Composition of Official Foreign Exchange Reserves
In three big areas – enacting a convincing joint economic policy to match pooled monetary policy, establishing sustainable economic growth and providing deep liquid markets for investors – Europe is still far away from that goal. The onus is now on Europe to show more energy and staying power on the long journey to internationalise the euro.
The currency starts off from a relatively high base of 20% of world reserves (Figure 1). But as commentators like Gary Smith have pointed out, this has remained broadly unchanged during most of the lifetime of the single currency.
Merz and Macron could provide new impetus
The leader with the greatest potential, at least in theory, to influence international currency matters is the new chancellor of Germany, Friedrich Merz, due to take office in just over a fortnight. Merz, together with Emmanuel Macron, now just two years away from stepping down after the French presidential election in April 2027, have a chance of providing new impetus.
Merz has made a start with the bold fiscal expansion measures for defence and infrastructure announced in the run-up to the agreement on a new coalition between Merz’s conservatives and the Social Democratic Party.
Coinciding with Trump’s undermining of the dollar, this has led to a general upgrading of international investors’ appraisal of the euro area’s future prospects. Financial markets’ optimism about Europe however seems to be directly proportional to onlookers’ geographical distance from Berlin, Paris and Brussels.
Underlining Europe’s predicament, the International Monetary Fund in its semi-annual outlook on 22 April lowered its growth forecast for the euro area to 0.8% in 2025 and 1.2% in 2026, both 0.2 percentage point lower than projected at the start of 2025. The IMF blamed Trump’s tariff policies for the general international downgrade.
As well as the most enticing opportunities, Merz arguably faces the gravest challenges. Spending the additional fiscal firepower without driving up inflation or causing disruption on ancillary European capital markets will be a difficult balancing act.
When Germany – in 1978 and 1991-92 – previously carried out poorly coordinated large-scale fiscal stimulus, the outcome was highly negative. In the first case this led to a German recession and the political demise of Chancellor Helmut Schmidt; in the second, to a near fatal implosion of the European Monetary System and another German recession.
Thoughtful European policy-makers such as Mario Centeno, governor of the Banco de Portugal and former chairman of the Eurogroup of European finance ministers, welcome the German package, but call for it to embedded within a well-considered European institutional framework
Unfortunately, many measures that would bolster the euro’s international status run counter to the fundamental leanings of Merz’s conservative supporters. Unease about the German Christian Democrats’ unplanned lurch to Keynesianism has been one of the reasons for Merz’s latest slide in opinion polls – hugely unwelcome for a politician still weeks away from forming his government.
Buttressing the euro’s status
Extending the Next Generation EU borrowing programme would be a logical way to capitalise upon global investor demand for the euro assets.
Supporting intelligent proposals by a working group reporting to the European Parliament to enlarge operational responsibilities of the European Central Bank and reinforce euro area market infrastructure would add to European resilience.
Promoting capital markets union to strengthen Europe’s market-orientated response to the climate crisis as well as to help finance infrastructure and defence projects is fully in line with Merz’s thinking – but faces institutional and political hurdles around Europe.
And taking further steps to promote banking union, for example by overcoming German hesitancy over a fully-fledged European Union deposit insurance scheme, would represent a major institutional landmark. All four of these measures would help buttress the euro’s status – but enacting each one of them, let alone all four together, would be an uphill struggle against well-entrenched resistance.
Last year currency experts Steven Kamin and Mark Sobel outlined the thesis that America itself rather than any outside player held the key to determining whether the dollar would suffer a decline in its international supremacy. Much more quickly than expected, Trump’s actions seem to confirm the Kamin-Sobel doctrine.
If the trend in coming years is to pick up further momentum and take on constructive shape, Europe will have to play its part in providing a viable dollar alternative. Can Europe step up to the plate? That is just one of the many open questions overhanging the future of the Old Continent.
David Marsh is Chairman of OMFIF.
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