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Wolfgang Munchau: The euro must be made more robust to rival the dollar

Section: Daily Dispatches

By Wofgang Munchau
Financial Times, London
Sunday, May 27, 2018

Many years ago I used to attend an annual seminar in pleasant surroundings in which the participants discussed the politics and economics of two European countries. There were usually two groups.

One would talk about foreign policy -- mostly transatlantic relations. The other discussed economics and especially the euro. At the end the two listened to each others' conclusions with polite boredom. The European Union would today be in a better place if the foreign policy folk inside and outside that room had made the euro their own project.

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The dollar, by contrast, has been an integral part of U.S. foreign policy for many years. Its role as the global anchor currency allows the United States to cut off an entire country from access to international commerce and finance, as in the case of Iran. Or a group of individuals as in the case of Russia.

The euro was not designed as a geopolitical instrument. I recall the debate in Germany in the 1990s. The Bundesbank deliberately rejected the idea of a strong international role for the euro, fearing it might conflict with the objective of price stability.

I also recall the debates among international economists about whether the euro could challenge the dollar as a global reserve currency. The opportunity was there. Serious academic papers were written. The fact that it did not happen was the result of a conscious political choice.

That choice is in part responsible for the EU's difficulty in finding an effective response to Donald Trump today. The biggest problem with the U.S. president's decision to pull out of the Iran nuclear deal is the extraterritorial effect. European companies that defy the U.S. sanctions would be cut off from U.S. financial and product markets. So would the banks that fund those companies. Multinational companies or banks cannot afford that. Mr. Trump can behave in this way because the U.S. is ultimately in control of all dollar-based financial flows, including those that originate outside the United States.

The EU cannot impose extraterritorial sanctions on U.S. companies that defy European policy. The euro is not as critical to them as the dollar is to Europeans. After the euro was introduced in 1999, it quickly became the world's second most important currency but still lags behind the dollar on most metrics. Its share of foreign exchange reserves was under 20 per cent at the end of 2016, compared with 64 per cent for the dollar, according to the European Central Bank. The gap was of similar magnitude in the categories of international debt and loans. The dollar leads the euro in foreign exchange turnover by a factor of three to one. The only category where the euro has almost caught up is that of a global payment currency. In the past decade the gap narrowed but it has widened again since the financial crisis.

In response to Mr. Trump's decision to cancel the Iran deal, the European Commission only managed to dig up the old blocking statute -- a ban on European companies complying with the sanctions. The problem is that the EU has no financial instruments to protect European companies. How, for example, would you compensate a European bank for no longer being able to transact in dollars?

The failure to develop the euro into a rival to the dollar also makes the EU more vulnerable to trade tariffs. This is mostly due to the trade surplus. This, in turn, is the result of the eurozone decisions as to how to tackle the debt crisis: by forcing crisis countries to run positive current account balances. One consequence of this policy has been a populist backlash of the kind we see in Italy right now. U.S. protectionism is another.

Before the financial crisis the eurozone ran a small current account surplus. By last year, it reached 3.5 per cent of economic output. The larger the surpluses became, the more dependent the eurozone had become on the rest of the world.

Instead of hyperventilating about Mr. Trump, Europeans might want to reflect on what got them into this mess. The EU would be more resilient today if it had not handled the eurozone crisis the way it did, and if its founders had made the euro more robust from the outset. Technically, it would still be possible for the EU to fix the problem, but that would require a degree of political union that goes far beyond even what Emmanuel Macron, the French president, has proposed. It requires at its core a mutualised debt instrument, a euro bond, as a financial instrument to underpin a large sovereign debt market. It would also require a broader mandate for the European Central Bank.

I am, of course, aware that there is no political support for this in northern Europe. But just wait until Mr. Trump imposes tariffs on BMW, Mercedes, and other European companies. Events are starting to intrude.


Wolfgang Munchau is an associate editor for the Financial Times.

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