What’s wrong with a weak euro?

The meek, Jesus famously assured us, shall inherit the Earth. European policymakers’ recent pronouncements, however, suggest they profoundly disagree with the Messiah.

Barely a single speech by EU leaders or officials these days fails to emphasise Europe’s underlying strength, resilience, or solidity. Policymakers also routinely stress the importance of Europe’s robust institutions, firm decisions, and the (latent) power of its single market.

The EU’s rhetorical muscle was on full display this week, when Danish premier Mette Frederiksen mentioned the word “strong” or “strength” eight times in a speech to MEPs unveiling her country’s EU Council presidency programme. Tellingly, Denmark’s official slogan for its six-month chairmanship is: “A strong Europe in a changing world”.

Paschal Donohoe, Eurogroup president, similarly called for a “stronger and more competitive euro area” to “further enhance our resilience” and “reinforce the international role of the euro” shortly after his re-election as chair of the (genuinely) powerful forum on Monday.

Claims of Europe’s actual or potential strength are, clearly, justified in many areas. Europe does, after all, have resilient institutions; and it should harness the economic and financial power of its citizens and companies.

However, such assertions are much more controversial – and potentially disastrous – when applied to the euro itself.

Many of the problems associated with a stronger currency are already visible. The euro’s value has surged in recent months, rising more than 13% against the dollar and more than 11% against the Chinese yuan since the start of the year.

The increase is, in part, a show of confidence in the currency. Investors, concerned at US President Donald Trump’s erratic policymaking, have sought to diversify their holdings away from dollar-dominated assets. For many, Europe seems a far safer place to park their money.

Unfortunately, these exchange-rate fluctuations are also causing growing headaches for European businesses and policymakers.

First, by raising the ‘price’ of European exports relative to their American and Chinese competitors, a stronger euro has exacerbated EU exporters’ woes at a time when Trump’s sweeping tariffs and fierce Chinese competition are inflicting serious economic pain.

Second, and relatedly, a stronger currency has rendered imports into Europe considerably cheaper, thus incentivising consumers to purchase foreign products instead of domestic goods.

This latter effect is, naturally, good for ordinary citizens. But it is also disastrous for businesses, especially in export-oriented industries such as automotive and pharmaceutical manufacturing.

For policymakers, it also means that inflation, which has only recently been tamed after three years of painfully high prices, now risks undershooting the European Central Bank’s 2% target.

Exorbitant privilege – or execrable burden?

Unfortunately, these issues would likely only become even more severe if the euro eventually displaced the dollar to earn the “exorbitant privilege” of being the world’s reserve currency.

For while the dollar’s dominance has allowed the US to borrow at exceedingly low rates (owing to the massive global demand for dollar-denominated assets), it has also harmed US businesses and, arguably, contributed to America’s decades-long industrial decline.

The Janus-faced nature of the US’s exorbitant privilege is explicitly recognised by many US officials. As US Vice-President JD Vance said last year: “I think in some ways you can argue that the reserve currency status is a massive subsidy to American consumers but a massive tax on American producers.”

Of course, no one expects the euro to displace the dollar anytime soon. Despite declining in recent years, the greenback still accounts for 58% percent of global foreign exchange reserves. The euro’s share, by contrast, is just 20% – down from around 25% a decade ago.

In addition, just under half of all cross-border banking and international bonds are denominated in dollars, as is roughly four-fifths of international trade. In a sign that investors’ faith in Europe may be limited, gold also recently surpassed the euro to become the world’s second-largest reserve asset.

Whence the dollar's continued dominance? There are many reasons, but they include Europe’s fragmented capital markets, its incomplete banking union, and, perhaps most critical of all, an insufficient number of ‘safe assets’, or risk-free investment products.

For instance, the total value of German bunds, the eurozone benchmark, is around €2.5 trillion. By contrast, the US Treasury market is worth a whopping $30 trillion. Berlin’s recent pledge to splurge €1 trillion on infrastructure and defence looks, in relative terms, like pocket change.

A historic warning

A much more serious and realistic danger, however, is that the euro, and perhaps other currencies like the yuan, gradually erode the dollar’s pre-eminence, thus eventually leading to the formation of a “multipolar financial system” in which no single currency dominates.

ECB President Christine Lagarde, who recently called on Europe to “seize” this “global euro moment”, has also predicted that the world is heading in this direction.

For many – although not for Trump – a multipolar financial system seems like a good idea, given that it would make the world less dependent upon the whims of an increasingly capricious US.

While this is partly true, the development of such a multipolar system also comes with significant risks.

After all, the last time a single currency failed to dominate the world’s financial system was during last century's interwar period, when the dollar gradually displaced the British pound – an episode which culminated in the moral abyss of the Second World War.

While the connection between the pound’s overthrow and the outbreak of the war is a matter of scholarly dispute, many economists believe that the presence of multiple competing currencies is a potential recipe for economic disaster.

In a remarkably prescient 2009 paper, the World Bank warned that “a multiple-reserve-currency setting” could trigger “credibility problems”, in which “holders of one major currency can easily shift to another, exposing the disfavoured currency to quick, sharp depreciation and the favoured currency to rapid appreciation”.

Such a dynamic could potentially threaten global financial stability “with consequences for economic activity and development in all countries”, they added.

Other studies – including by the ECB itself – have reached broadly similar conclusions.

How can one address this problem? For the World Bank, the volatility of such a multiple-reserve currency system can only be tamed by a  “managed international system” in which competing financial blocs coordinate their respective monetary policies.

However, they also warned that Washington is unlikely to willingly accede to the loss of its exorbitant privilege.

“In order to mitigate an abrupt loss of power, the United States is likely to be selective in its support for multilateral institutions, and will concentrate instead on the bilateral relationships in which it can best project and maintain its economic power,” they noted.

The parallels with today's world – defined by US trade wars and Trump’s deep-seated scepticism of multinational bodies like the World Trade Organization – are eerie.

Jesus, of course, may have been wrong that the meek would inherit the Earth – he was (partly) human, after all. Unfortunately, it’s looking increasingly likely that, meek or not, there won’t be much of a world for Europe to inherit.

Economy News Roundup

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The EU must accelerate efforts to “de-risk” from China, says Ursula von der Leyen. The European Commission president said Beijing's recent export restrictions on so-called rare earths – used to manufacture smartphones, electric vehicles, and other advanced technologies – show that her flagship policy of “de-risking but not de-coupling” from the world’s second-largest economy must “speed up”. “[W]e have learnt the lesson about the extent to which dependencies are vulnerabilities,”  von der Leyen said in an address to the European Parliament in Strasbourg. “And how tech, trade and security are inherently linked. De-risking is simply a matter of European independence.” Read more.

Paschal Donohoe re-elected Eurogroup president. The Irishman received unanimous support from his fellow eurozone finance ministers just hours after Spain’s Carlos Cuerpo and Lithuania’s Rimantas Šadžius pulled out of the race to lead the powerful forum. In a statement, Donohoe pledged to be "a genuine and honest broker" who will ensure that "all voices and positions are taken into account". "It will be my task to further strengthen our common currency area and facilitate tangible progress on our key work streams during this next mandate – from budgetary coordination to the Capital Markets Union, and from the digital euro to the Banking Union," he added. Read more.

EU’s push to boost military expenditure could undermine the bloc’s financial stability, says Denmark. Stephanie Lose, Copenhagen's economy minister, told Euractiv that Europe must ramp up defence spending “very quickly” to deter Russia’s growing military threat, but warned this outlay may pose an additional “risk” to the bloc’s economy, which is already reeling from the twin impact of US tariffs and fierce Chinese competition. “At the same time as there is this unrest in the economies across the world, [we] need to boost defence spending very quickly,” said Lose, whose country took over the rotating Council presidency from Poland earlier this month. “That is a risk factor for our economies, because if we don't combine that with wise decisions on ways to a more sustainable path for public finances, then I guess it will be a problem in terms of increased debt levels and unsustainable finances." Read more.