Politics in Europe: Seizing the Opportunity of a Wobbling King Dollar

The U.S. dollar’s reign as the world’s reserve currency is being called into question, and Europe stands poised to take advantage of this upheaval. Under the tumultuous economic policies of the Trump administration, the dollar has depreciated, leading investors to seek alternatives. Among the most viable contenders is the euro, which may finally address long-standing political barriers to becoming a credible global currency.

The Shift in Economic Power

Since Donald Trump took office, his administration has enacted a range of volatile economic policies that have directly impacted the dollar’s strength. As uncertainty grows regarding the transatlantic alliance, discussions have begun regarding the establishment of a euro zone safe asset that could rival U.S. Treasury bonds. Trump’s administration has openly questioned the benefits of holding the dollar as the global reserve currency, leading to a noticeable decline in its value.

The dollar index (DXY), which measures the strength of the dollar against key trading partners, has dropped approximately 10% since Trump’s inauguration. This decline has prompted a search for alternative currencies, with the euro emerging as the only realistic candidate.

Historical Context of Currency Supremacy

The global currency landscape is not as straightforward as the current dominance of the U.S. dollar may suggest. Economic historians Barry Eichengreen and Marc Flandreau illustrate that historically, multiple currencies can claim a stake in international finance. During the interwar years, the British pound and the U.S. dollar vied for the top spot, with both currencies experiencing ups and downs based on economic conditions.

Before World War I, even the German reichsmark was prominent in global markets. The key takeaway is that the dominance of a single currency is atypical, and the rise of alternatives is possible under the right conditions.

Three Tests for Currency Globalization

For the euro to confidently step up and fill the shoes of the dollar, it must pass three crucial tests:

1. Freedom from Capital Controls

A fundamental requirement for a currency’s international reach is the absence of capital controls, allowing free access for foreign investors. Both the euro and dollar meet this criterion; however, the Chinese renminbi falls short due to strict government management of its exchange rate and flows.

2. International Circulation

Another critical factor is the currency’s international circulation. While a current account deficit is often assumed to be necessary for this, it is not universally applicable. Historically, countries like the U.K. maintained their global standing with net exports and demonstrated that lending to foreign entities is an effective way to circulate currency. The euro zone’s well-established banking sector supports its case; although it still lags behind the U.S. in terms of global cross-border lending.

3. The Need for a Safe Asset

The absence of a “safe asset,” akin to U.S. Treasury bonds, poses a significant barrier for the euro zone. Such assets form the bedrock of modern financial systems, serving as collateral for trades and benchmarks for pricing. Despite the stability provided by German Bunds, their scarcity compared to Treasuries undermines their effectiveness as a substitute. European policymakers have explored options to create safe assets, but political hurdles have historically stymied these discussions.

The Political Landscape: An Emerging Opportunity

However, the political landscape may be shifting in favor of a euro zone safe asset. Recent events demonstrate how economic policies can significantly influence public sentiment. For instance, Canada’s political dynamics have transformed rapidly in response to Trump’s economic stance, highlighting that political attitudes can change swiftly in the wake of uncertainty.

While deeper financial integration among euro zone countries appeared unlikely, rising nationalist sentiments and the growing threat to mainstream parties may catalyze discussions around joint liability for public debt. Germany’s recent legislative moves signal a willingness to explore new fiscal approaches. This new political era could offer the impetus needed to establish a credible euro zone safe asset, which would substantially enhance the euro’s position as a viable global currency.

Conclusion: The Euro’s Path Forward

The shift in global economic dynamics presents Europe with a unique opportunity to position the euro as a leading international currency amid a declining dollar. While significant hurdles remain, the potential creation of a euro zone safe asset backed by collective political will could reshape the future of global finance. In an age where America-first policies sow discord, Europe may, for the first time, find the resolve to unify and elevate its currency on the world stage.