With the dollar faltering, European policymakers have an opportunity
Publicado en The Economist, el 16 de abril de 2025
Europe’s first reserve currency was the tetradrachm, upon which was inscribed an owl. The symbol of wisdom was intended to inspire trust in the rulers of ancient Athens. Indeed, the bird features on the Greek version of the €1 coin today.
That is not the only way in which the tetradrachm would be recognisable to modern economists. As Barry Eichengreen of the University of California, Berkeley, notes, across history every leading currency has belonged to a republic or democracy; Athens was the latter. Restraint on the powerful, as provided by voters, promises a degree of stability—a crucial ingredient, along with a large economy and military might, for any reserve currency. It is the absence of such stability in America today that is prompting investors and policymakers to question the dollar’s role as the world’s reserve currency.
With the greenback struggling, could this be the euro’s moment? Both Christine Lagarde, president of the European Central Bank (ecb), and Paschal Donohoe, head of the Eurogroup, a forum for euro-zone finance ministers, have recently spoken about ways to enhance the currency’s international role. The euro is not about to supplant the dollar. But it may serve an increasingly important function. And if policymakers seize the moment, potentially epochal shifts in the global financial order could work to Europe’s benefit.
Since its birth in 1999, the euro has been a contender for global status. In the run-up to the financial crisis of 2007-09, European officials were hopeful that it might, in time, rival the dollar. Then came the euro crisis of the 2010s. The ECB was not set up to be a lender of last resort, which made government bonds vulnerable to runs. Europe’s banking system was split along national lines and prone to doom loops connecting shaky sovereign debt with shakier financial institutions. Capital markets were too small to compensate for such risk. The euro zone provided few safe assets for those looking to park cash: bond issuers were either too parsimonious (in the case of Germany) or lacked credibility (in the case of Italy and Spain). Common debt, backed by the whole bloc, barely existed. Dismal economic-growth prospects then forced short- and long-term yields below zero. With European assets offering low returns, there was little demand for euros, and no global role for the currency.
Shifting plates
Today the euro is a solid but distant second to the dollar, counting for a fifth of global central-bank reserve holdings against the greenback’s three-fifths, with similar numbers for foreign-currency bond issuance. Over the past decade, as the world has gradually diversified away from the dollar, the euro has struggled to gain ground. Yet some European officials now believe that may change, for four reasons.
The first is that the euro zone’s financial architecture has become more secure. The ECB has emerged as a lender of last resort in all but name, a process that began in response to the euro crisis under Mario Draghi, then the central bank’s president. During the covid-19 pandemic the bank established a bond-buying programme with a budget of more than €1.8trn ($2.1trn). When yields on sovereign bonds widened uncomfortably quickly amid inflation in 2022, policymakers set up an unlimited bond-purchasing scheme to prevent such spreads from blowing out in future.
Investors have also seen that the European Union will support struggling governments, and will do so in a generous fashion. During the pandemic, the bloc created a recovery plan worth €807bn, funded by common EU debt, to aid laggards. Moreover, the ECB is now firmly established as the supervisor of Europe’s 114 largest banks, which together hold 82% of the continent’s total banking assets.
On top of this, investing in Europe has become more straightforward—a second reason for optimism. Europe’s pandemic-recovery fund created lots of common debt, and thus safe assets that are truly European. Germany is even about to start spending big, amid a continent-wide, deficit-funded binge on defence spending, which officials believe should rise from 2% to 3.5% of GDP in the coming years.
The third reason is that Europe’s institutions now look more attractive, at least when compared with America’s. Hard-right parties are strong and gaining ground in countries including Germany and France. One is in power in Italy. At the same time, however, the euro is the common currency of 20 sovereign states, and has a fiercely independent central bank overseeing it. Members would struggle to agree on any change to how the currency is governed, let alone the sort required to weaponise it for geopolitical gain. What is more, sanctions on other countries would require the consent of all 27 EU members. The rule of law is central to every aspect of the EU; the bloc’s checks and balances are not in doubt. Nor is the broad consensus, forged over decades of compromise and conciliation, that the EU should be as open as possible to trade and foreign investment. The ECB has created a framework for providing euro liquidity to non-euro countries, which could be more attractive to crisis-stricken countries than the Fed’s swap lines if Mr Trump continues on his current course. Nobody wants to give the American president leverage.
Old continent, new tricks
And then there is the final reason for optimism: the state of international commerce. As America withdraws from global trade, Europe will come to play a more important role. Goods and services invoiced in euros will create ancillary markets in the currency, including in trade financing, insurance, and hedging derivatives for interest rates and currencies. Although over-the-counter (off-exchange) currency derivatives remain dominated by the dollar, interest-rate derivatives in euros have recently overtaken those in the greenback. New trade links will also lead to the creation of euro-based credit and deposit accounts across the world, which will, in turn, create demand for euro assets and, ultimately, euro central-bank reserves, since any lender of last resort must stock up on the currencies held by local financial institutions.
Europe has a chance to assume leadership of a new liberal trading order, which would create opportunities to shape the financial system. Ursula von der Leyen, president of the European Commission, cheerfully notes how “many countries around the world [want] to work closer with us”. According to research by the ECB, in the 2000s the euro zone’s eastern neighbours began to invoice trade in euros because of closer commercial ties with the bloc; the same dynamic may now play out elsewhere. Capital tends to follow geopolitical alignment. Research by Elisabeth Kempf, then of the University of Chicago, and co-authors finds that asset managers and banks invest less in countries led by governments with political leanings different to their own (as measured by their political donations or affiliations).
Yet such opportunities will not fall into the lap of European policymakers. Difficult reforms will be required, too. For a start, countries with lots of debt, not least France and Italy, will have to foster economic growth so that they remain fiscally sustainable, rather than adding to the pile of investible bonds simply to make their budgets work. Germany, the Netherlands and the Scandinavian countries face the opposite task: they need to use their fiscal space for investment, in the process creating safe assets. Economic growth across the EU would help lift returns of all euro assets, including government bonds, in turn making them still more attractive.
Europe also needs larger and deeper capital markets to give investors more assets in which to put their money. Policymakers have so far focused on easy gains when seeking to tie fragmented national markets together, concerning themselves with matters such as the process by which assets are securitised, rather than more contentious topics such as the harmonisation of bankruptcy laws and business regulation. Faster progress on the ECB’s plans to connect third countries to its internal payments system would help, as would an international leg for the digital euro.
European officials would like to make the continent less dependent on both America and China. A more international euro would lower borrowing costs for national governments, which would be supremely helpful at a time of rising defence spending. For the moment, few politicians will spell out such ambitions, since they are aware that doing so would provoke the wrath of the Trump administration. But that does not matter. International finance has a logic of its own, and it can bring down currencies even in the absence of grand speeches. Just ask the Athenians. ■