Lagarde's master plan to vanquish the dollar

Telegraph

2 days ago

Despite the tough talk about slapping 50pc tariffs on the EU, Donald Trump has given Brussels a golden opportunity.
After years of disappointment, false hope and crises, the euro could at last wrest international dominance away from the dollar to become a – and possibly the – global reserve currency of choice.
Or so Christine Lagarde hopes. The president of the European Central Bank (ECB) set out her master plan last week to at long last fulfil the dream of leading the financial world.
'Moments of change can also be moments of opportunity. The ongoing changes create the opening for a 'global euro moment',' she said in a speech in Berlin, in which she retold the story of the pound losing its dominance a century ago amid the rise of the US dollar.
'This is a prime opportunity for Europe to take greater control of its own destiny.'
The opportunity to which she refers is the rise of Trump and the shattering of the old order. The dollar has been the default currency for global trade for decades, with contracts, assets and deals all priced and conducted in the greenback.
But the US president's decision to slap tariffs on allies and foes alike has shaken faith in this way of working.
'Multilateral cooperation is being replaced by zero-sum thinking and bilateral power plays. Openness is giving way to protectionism,' Lagarde said. 'There is even uncertainty about the cornerstone of the system: the dominant role of the US dollar.'
Controlling Europe's destiny
Dean Turner, economist at UBS, says the dollar's share of foreign currency reserves has been falling for years, and recent events should push more funds into euros 'at the margins'. This is already happening: the single currency has risen by 9pc against the dollar since Trump took office.
The dollar slid again on Monday as China accused the US of violating the deal struck between the world's two largest economies in Switzerland last month.
The latest spat highlighted international fears over America's position and sent the greenback down 0.7pc against the euro. It left the single currency trading at more than $1.14, close to its highest level for more than three years.
'Given the high degree of policy uncertainty, investors will continue to reassess their dollar exposure, and that is going to benefit currencies like the euro,' Turner says. 'The euro is the most liquid alternative to the dollar.'
Traditionally, the US benefits from what is known as an 'exorbitant privilege' in financial markets. Seen as the safest haven by investors, any time the going gets tough, global cash flows into America. It helps the government finance its vast deficits, and funds businesses and households too.
Lagarde wants a slice of the action. A bigger role for the euro would lower borrowing costs, boost Europe's economies, insulate the Continent from volatile financial markets and 'protect Europe from sanctions or other coercive measures', as she put it.
The ECB chief said: 'It would allow Europe to better control its own destiny.'
Making it happen is easier said than done. While Trump has reviled many global investors, that is not enough on its own to push cash into Europe. The bloc needs to become more appealing too.
Lagarde's prescription for turning this short-term gain into long-term dominance includes the eurozone taking the lead in geopolitics – both in global trade and in military terms – and developing deeper capital markets to give investors more to invest in.
More political unity, which breeds stability, is also required.
Distant dreams
None of these goals are straightforward.
Take the idea of stepping up to the plate militarily. Europe has certainly been prompted into promising to spend more on defence by the war in Ukraine. Friedrich Merz, Germany's new chancellor, has pledged to spend as much as 5pc of German GDP on defence, with as much as €1 trillion (£840bn) of infrastructure and military spending on the way in the coming years.
Yet a defence spending spree does not by itself create a new military superpower, says Michael Every, global strategist at Rabobank.
'Just saying you are going to spend a lot of money on the military doesn't give you a military – it takes decades of investment to build one up,' he says, noting that Europe also relies on imported energy and other critical resources, which leaves it vulnerable.
A shift in mindset is also required. America's status was also built on its willingness to act as the world's policeman, not just a capability to defend its own borders, says Bilal Hafeez, chief executive at MacroHive.
'Defence helped the dollar become a reserve currency. The US provided military support for foreign countries – they underwrote Japan's defence, and as a result the Japanese bought Treasuries and got into the dollar system,' he says.
'Is Europe willing to provide military support for non-European countries?'
The other planks of Lagarde's master plan also seem distant dreams.
An extra trillion euros of German borrowing means an extra trillion euros of high-quality assets for global investors to buy, which is appealing. But the commitment also draws attention to the weakness of eurozone capital markets.
While the US has a vast, deep market for its $36 trillion (£27 trillion) national debt, the eurozone is split into member states with different levels of borrowing and risks. Few jointly issued bonds exist in Europe, so it is not a direct alternative to the big, liquid American market.
Changing that would require German taxpayers to underwrite French, Italian or Greek debt. They are understandably reluctant.
Uncomfortable consequences
It is not even obvious that becoming the world's reserve currency would be beneficial for all of the eurozone.
'There are consequences to being the world's reserve currency,' says Turner. 'It would put a premium on the euro, that means the euro goes up against other currencies.
'When you're an economy that is still heavily dependent on exports, that is going to make life quite challenging for some members of the eurozone.
'Part of the success of the German export model over the last 20-odd years has been the fact it has had a relatively cheap currency through a significant period of that.'
That is part of the reason Trump is unhappy with the status quo.
'America is walking away from that traditional role because it comes with higher asset prices, which means greater socioeconomic polarisation, and deindustrialisation via higher trade deficits,' says Every.
'Tell me how a net-exporting European economy is going to benefit by switching to be a net importer? It won't. To make consumers out of Germans rather than car producers is not something which anyone in Germany wants to do.'
Lagarde sees a chance for a 'global euro moment'. But to realise her vision, she has to convince a lot of people in the eurozone to do a lot of work first – and that's before she even has a shot at convincing the rest of the world.