EU fantasies of toppling the dollar are totally delusional

Telegraph

6 hours ago

It's a nice problem to have amid the Trump-inspired madness that grips today's foreign exchange markets. But it's a problem none the less. The Swiss franc keeps on appreciating, and there seems to be almost nothing the authorities can do to stop it.
Increasingly alarmed by its trajectory, the Swiss National Bank last week cut its official policy rate back down to zero, and there is now talk of rates going negative again by summer's end.
But to little effect. Switzerland's safe haven attributes have rarely been in such high demand.
Rising geopolitical tensions have combined with growing loss of trust in the dollar as the bedrock of the global economy to send the franc soaring, almost regardless of whatever rate of interest it carries.
Lest it be gold, there are few repositories of wealth thought more secure than Switzerland.
Contrast that with the UK, where Bank Rate is still firmly stuck at 4.25pc with stubbornly persistent inflation to match.
Thanks substantially to the lower import prices that the surging franc brings about, prices as a whole are going down not up; there is little or no cost of living crisis.
This is great for consumers, not so much for Swiss industry, which has to match these deflating prices at home and abroad. But thus far at least, it's coped remarkably well.
I've never bought the idea that a competitive economy needs a weak currency.
Persistent devaluation has been the British way for decades now, and little good has it done either.
At best, it's only smoothed the decline – a tranquiliser to avoid having to face up to the hard yards of painful structural adjustment. While the UK has grown poorer, the Swiss grow ever richer – living proof that a strong currency goes hand in hand with a competitive economy. The one is a reflection of the other.
Bad, uncompetitive companies are quickly weeded out and dispensed with, while the disciplines of having to compete with cheaper foreign goods and services forces the survivors into imaginative innovation and productivity gain.
You can, however, have too much of a good thing, and this is the unfortunate position that Switzerland now finds itself in. Broadly speaking, Switzerland produces in appreciating francs, but sells in equally fast depreciating dollars. There is only so far countervailing productivity improvement can take you.
Theoretically, Donald Trump's tariff policies should make the dollar stronger, in that all other things being equal, they ought to reduce the size of the deficit.
But it hasn't worked out that way. In practice, they've only further undermined international confidence in US economic management more widely. To most observers, it looks as if the White House is deliberately trying to tank the dollar.
And on one level, it is; a depreciating dollar temporarily helps domestic producers by making imports more expensive.
When combined with tariffs – effectively a sales tax on foreign producers – US industry gets a double boost.
Trump wants the best of both worlds; he wants a weak dollar, but he also very much likes the dollar's commanding position in the global economy for the geopolitical power it bestows.
Sadly for him, it's not clear he can have both. To support a weak dollar, he needs to make dollar assets less attractive to foreign investors.
As Stephen Miran, the head of Trump's council of economic advisers, has suggested, this might be achieved by imposing a withholding tax on income generated by US assets, or by converting foreign holdings of US Treasuries into 100-year bonds.
Trump's problem is that the less attractive the US makes itself to foreign investors, the less likely it is that the dollar can sustain its dominant reserve currency position.
Use of the dollar for sanctions against countries the US has got a problem with has further undermined trust in the currency as both a store of value and reliable means of exchange.
International trust relies crucially on the idea of a global order based on agreed rules, the very thing Trump wants to dispense with.
So the dollar turns weaker, and together with the Trump tariff shock, it drives up domestic US inflation.
Despite almost daily berating from Trump, Jerome Powell, the chairman of the Federal Reserve, is sitting on his hands and refusing to reduce interest rates in the precipitous way the president demands.
The more Trump complains, the more Powell digs in. Determination not to give way has become a matter of principle, almost regardless of its economic merits.
Powell's stance is totemic in the wider struggle to protect institutional integrity from presidential diktat. Once Federal Reserve independence goes, the whole fragile structure of dollar hegemony begins to crumble. Even Trump must know that.
Meanwhile, Europe is cutting fast – with the notable exception of the UK, where inflation remains a problem.
Normally, America's higher interest rates relative to Europe would cause the dollar to strengthen, but the trust issue has provoked a very different response – a weaker dollar despite a widening interest rate gap.
Christine Lagarde, the president of the European Central Bank, sees Trump's antics as an opportunity for a 'global euro moment'. It has long been the ambition of European policymakers to look the mighty dollar in the face, and eventually usurp its position in the international monetary system.
This has always seemed fanciful. For all its grandstanding, the EU remains a disjointed confederation of fiscally sovereign and often deeply divided nations, with no centralised Treasury function to speak of, no banking union and no unified sovereign debt market.
This makes its monetary union acutely vulnerable to existential crisis. Lagarde might think of herself as queen bee, but her powers and reach are remarkably limited.
As long as this remains the case – and there is little sign of it changing – Lagarde's musings are just delusional nonsense.
Where reserve managers have been diversifying away from the dollar, it has, moreover, tended to be into gold, not the euro. Indeed, gold recently overtook the euro as the biggest central bank reserve asset after the dollar.
A rather more potent long term threat comes from China, whose central bank digital currency and the infrastructure being built around it are deliberately designed to provide an alternative to the dollar for trade and investment.
Those who take umbrage at Trump's America can try China instead. Who's to say it's less reliable than a country that slaps record tariffs on some of its closest allies?
Regrettably, Switzerland is just too small to act as a global reserve currency. As it is, it struggles to manage the inflows of international capital looking for safety amid the bedlam of today's world.
Already, the Swiss National Bank balance sheet is swollen by its various currency interventions to a size considerably bigger than that of Switzerland's entire economy. It can surely go no further in printing Swiss francs to buy foreign assets.
But as I say, it's a nice problem to have.