EU leaders push to boost global role of euro as US ties fray
As American and European policymakers know well, global currency dominance and exchange rate movement are different things. But there’s a decent argument that Europe’s push to widen euro usage necessarily involves some revaluation of the single currency.
As Transatlantic ties fray and European Commission President Ursula von der Leyen warned of lines that “cannot be uncrossed” after President Donald Trump’s bid for the US to acquire Greenland, European Union leaders and finance chiefs this past week have launched another push to bolster the bloc’s economic clout and reposition its defense.
With the Munich Security Conference as the backdrop, an informal EU summit last week brought renewed impetus to deepen European capital markets integration. Leaders also discussed possibly expanding joint euro debt sales and – led by the European Central Bank on Saturday – widening euro access, liquidity and financing worldwide.
Some of this has been on the table before. But the urgency for action is now evident in a willingness for a two-speed advance with six core countries – Germany, France, Italy, Spain, the Netherlands and Poland – in the vanguard if agreement among the 27 is too cumbersome or slow. An EU6 summit is due early next month.
The plans are likely necessary, even if not yet sufficient, to expand the role of the euro and allow it to absorb some of the nervousness about the world’s overexposure to dollars at a time of enormous US political and economic upheaval.
Whether that greater global role brings a less welcome appreciation of the euro’s value is another question.
As finance chiefs on both sides of the Atlantic ponder the potential for at least some shift in the scale of dollar dominance in reserves, trade, invoicing and commodity pricing, they have differing takes on any related exchange rate fallout.
Trump’s administration sees a “strong dollar” primarily in terms of the currency’s reach and pervasive use in cross-border finance – an extension of American power unrelated to the ebbs and flows of the exchange rate itself. The presumption is that the Trump team sees an unwinding of the dollar’s overvalued exchange rate as an integral part of its global trade reset.
Currency experts, such as Cornell professor and former IMF official Eswar Prasad, think a gradual weakening of the dollar’s exchange rate is possible without damaging its international dominance.
But Prasad, in a new book published this month called The Doom Loop, says this dominance, even though durable for reasons of inertia and scale, may well be at the heart of mounting global economic instability. And if that reaches a crescendo, the search for adequate alternatives inevitably rises, as gold’s parabolic recent price gains attest.
“While dollar dominance might prove a saving grace at times of crisis, it is that very dominance which has a destabilizing effect worldwide,” he wrote. “It exposes other countries to the mercurial and often undisciplined economic and financial policies of the United States.”
SWEET AND SOUR
Europe, on the other hand, clearly wants to lift the euro’s role but is far less keen on the exchange-rate appreciation that may follow, mainly because it would hurt export competitiveness at a time of great global trade uncertainty and further dampen inflation in the slower‑growth region.
Much like its US counterparts, it would like the “exorbitant privilege” of being a bigger reserve currency but not the bloated exchange rate valuation that might go with it.
But if the US side were happy with gradual dollar slippage on the exchanges and only a modest reduction in the dollar’s usage per se, would the Europeans be happy with the flipside of that scenario?
AXA Group Chief Economist Gilles Moec argued this week that disentangling the exchange rate impact from global usage was theoretically correct, but it would be hard to see any significant one-off shift not affecting the euro’s value.
Moec makes the point that during the last transition between dominant reserve currencies over a century ago, between the two world wars, when sterling ceded prominence to the dollar, the dollar appreciated on trend.
Even though the US unsuccessfully tried to resist that rise by devaluing the dollar against gold at the time, he points out, demand from global investors for the new reserve currency mechanically won out.
“Our point here is that the European Central Bank cannot completely disconnect its support for an upgrade in the euro’s global role from monetary policy,” he concluded.
The plus side is that a “more assertive role” for the euro could be positive for the EU by triggering regular inflows from foreign investors into euro assets at a time when Europe needs it. What’s more, a stronger euro could aid a shift from an export-led economy to a domestically led growth mode.
“To ease the transition, though, a flexible monetary policy would be necessary to avoid a too brutal decline in competitiveness,” Moec concluded.
If Europe now feels it also needs to cross lines that cannot be uncrossed, then maybe it just has to take all that on the chin.