International investors are progressively rebalancing portfolios away from the dollar as a result of erratic policies from Donald Trump’s new administration. But any significant shift towards the euro – the world’s second largest reserve currency – is likely to be held back by Europe’s relatively poor economic performance and lack of progress in areas such as the banking union and capital markets union.
That was the general view of an OMFIF advisory council meeting on 8 May – grouping two dozen economists and financial experts from Europe, Asia, Africa and the US. The meeting marked the first under the chairmanship of Norman Lamont, former UK chancellor of the exchequer.
Speaking in his new role, Lamont remarked: ‘Having been a member of the advisory council since its inception, I’m very pleased to be continuing as chairman. I would like to thank Meghnad Desai for all his hard work and dedication over the last 15 years of leadership. I will continue with his effort to give direction and impetus to this very knowledgeable and experienced group of people from around the world.’
Changing sentiment to dollar dominance
One council member expressed confidence that the euro bloc – which he deemed as including sterling and the Swiss franc as well as the European single currency – would enjoy strong capital inflows. This would come as a result of a surge in investment in infrastructure and defence heralded by the new German government under Friedrich Merz.
Voicing general unease about growing distrust of US assets, one US participant quoted Ernest Hemingway’s famous dictum on the timing of bankruptcy: ‘Two ways. Gradually, then suddenly’. He cited this as an indication of how underlying investor sentiment could build uncontrollably into a rapid change in so-called ‘dollar dominance’ unless the US took firm corrective action.
The pro-euro participant at the meeting was much more confident than others in the euro area’s ability to transition to a capital markets-based system for financing, moving away from bank loans, which would improve Europe’s overall inevitability. But – despite strong doubts on the realism and sustainability of US policies – other members were cautious about predicting a rapid across-the-board move away from the US currency.
‘Incoherent’ and ‘utterly unrealistic’
There was fierce criticism of some major tenets of the Trump economic approach. Participants cited challenges to the Federal Reserve’s authority, ‘abuse of financial sanctions’ and verbal attacks on countries ranging from Denmark (over Greenland) to Canada and Panama, as factors weakening trust in the US as a ‘safe haven’. One participant noted that the administration’s messaging on the dollar, marked by apparent indecision over whether a strong or weak currency was preferable – was ‘incoherent’. Plans to use tariffs and a weaker dollar as instruments to reindustrialise the US were branded as ‘utterly unrealistic’.
While some agreed that the dollar was overvalued, proposals by Stephen Miran, Trump’s senior adviser, for a ‘Plaza style’ agreement to weaken the dollar (echoing the 1985 accord to bring down the US currency’s bloated value) were not seen as feasible.
The ideas espoused by the chairman of Trump’s council of economic advisers were deemed unviable, partly because important developing economies such as China and Mexico – which had not figured in the agreement of 40 years ago – would be unlikely to be bound by a new accord. Also the European Central Bank appeared to be prepared to continue cutting interest rates – a sign that the euro area authorities were not interested in a further strengthening of the euro.
A US speaker at the meeting noted that the dollar’s dominance was not ‘pre-ordained.’ There was no immutable reason for the US currency’s global status. One way to maintain this role was for the administration to enact more balanced policies especially on curbing the budget deficit. Policies for reducing taxes lowered the likelihood of this outcome becoming reality.
One participant from Asia pointed out the wrongheaded nature of Trump administration rhetoric on the ‘hollowing out’ of US manufacturing industry. Pointing out the far higher growth in per capita real gross domestic product growth in the past decade compared with Europe, this member said: ‘The narrative from Trump that the US has been losing against the world doesn’t make sense. Why have more American economists not raised that? They must question this argument.’
Growing importance of stablecoins in the US
The council discussed the position of stablecoins in the US, partly as a means of maintaining the dollar’s premier role. One US participant closely involved in the process said: ‘Blockchain and stablecoins reduce the cost of transactions by a large fraction, so it has incredible potential. For this reason, the movement for stablecoin has more support in the dollar area.’
Another speaker opined: ‘Review of the international monetary system is long overdue. This is not just about the US and China, it is deeper than this. One instrument for the US administration to keep the US “dominant” is the use of stablecoins. How is the use of private stablecoins going to keep the dollar as an important currency for trade?’
A developing country participant said: ‘With technology comes evolution, for example, payment systems. The word “dominance” doesn’t translate to equity. The Global South doesn’t have equity on this. It is not a question about increasing the dominance of one currency and reducing that of the other, but rather about bringing more equity to the world.’
David Marsh is Chairman and Andrea Correa is Senior Economist, Economic and Monetary Policy Institute at OMFIF.
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