02 03 2021
The EU Tries To Challenge The Dominance Of The US Dollar Yet Again
In light of the recent political, economic, and technological developments, the European Commission –the EU’s executive branch– has put forth a new strategy to increase the share of the Euro in global financial transactions and to break the historical influence that the US dollar has had on the economic policies of the Union’s member-nations.
Europe’s historical struggles with dollar hegemony
Europe’s discontent with the global monetary system being structured around the US dollar can be traced all the way back to the 1960s –decades before the creation of the euro to challenge the dominance of its American counterpart over global financial transactions.
At the time, then-French-finance-minister Valéry Giscard d’Estaing coined the term “exorbitant privilege” –a phrase still used to this very day to describe the economic and monetary advantage that the US possesses due to the dollar’s status as the world’s reserve currency.
And not much seems to have changed in the last half-century or so.
The euro — which was created in 1999 with the belief that it could ascend to the global status of the dollar and rival its power — has failed to deliver on this promise and has seen its influence over the world economy diminish following a slight period of growth that accompanied its launch.
While the EU’s single currency has managed to compete with the US dollar in terms of international payment and billing — where both currencies are employed in about 40 percent of transactions worldwide–, it has fallen short in terms of other financial aspects such as global loans, deposits, bonds, and global foreign exchange reserves, where the euro’s share amounts to only a fifth of the market compared to the dollar’s majority control.
To add more insult to injury, a study by the International Monetary Fund (IMF) revealed a massive disparity in favour of the dollar when it comes to the currency used for trade between the United States and countries of the eurozone, with the 19 EU members paying for over 90 percent of their US imports in US dollars and receiving around 75 percent of their export payments in the same currency.
In a 2019 interview with the Financial Times newspaper, Indian American economist Gita Gopinath, who has been the Chief Economist of the IMF since 2019, argued that the substantial involvement of the dollar in international commerce has allowed it to play a larger role in the overall financial sector.
“For many emerging markets, over 80 per cent of their imports are invoiced in US dollars. To protect themselves against currency movements, it is quite natural that they will choose to save in dollars, which in turn leads to dollar dominance in asset markets,” she explained.
This massive global presence has resulted in an ever-expanding dollar-based worldwide network of trade and holding assets that only serves to further cement the currency’s status as an unshakable foundation of the global financial system upon which a large part of the world has built its economic infrastructure.
The EU has taken action to boost the use of the euro
The EU has been increasingly making economic moves in recent years aimed at improving the global standing of the union’s common currency.
On January 19, 2020, –a day before then-President-elect Joe Biden was sworn into office– the European Commission put out a statement of intent that set the tone for the future of the euro-dollar rivalry.
It came in the form of a written statement that detailed the institution’s plan to encourage the use of the euro on an international scale.
According to the document, the ultimate goal behind strengthening the position of the euro as an alternative for the US dollar is so that the EU “can reinforce its open strategic autonomy ” and avoid “the effects of the unlawful extra-territorial application of unilateral sanctions by third countries.”
The move was also spurred by the COVID-19 pandemic that the Commission believes has revealed “vulnerabilities in the dollar-dominated international financial system.”
As a result, the European executive branch argues that breaking the dollar’s dominance over global markets –by promoting the use of the euro– would dilute the financial risk tied to a potential crisis in the US and lead to “greater systemic stability”, as the global economy would no longer hinge on the value of one centralized currency.
In addition, the released document contained a 15-point blueprint for broader worldwide adoption of the euro, including the implementation of long-discussed initiatives such as the establishment of the banking union and the capital markets union; two institutions that would allow EU countries to merge their financial sectors, therefore further strengthening their global influence.
Furthermore, the European Commission will encourage and facilitate the use of the euro as a denomination and billing currency for investments, particularly in the sector of energy and raw materials, by holding meetings and getting feedback from financial regulators, investors, and industry leaders.
Contrary to what it may seem, these new proposals are not a ground-breaking development, but rather the latest in a series of measures that the EU has been taking to promote its own currency at the expense of the dollar.
On September 12, 2018, during the annual EU State of the Union address, then-president-of-the-European-Commission Jean-Claude Juncker expressed the ambition of his administration to match and even surpass the dollar in terms of influence over the global economy.
He also pointed out the absurdity of Europe paying for 80 percent of its energy imports in U.S dollars, and of European companies also using the rival currency to buy products such as airplanes from other European manufacturers, adding that “The euro must become the face and the instrument of a new, more sovereign Europe.”
Furthermore, Juncker told the European Parliament that he wants the EU to become a “major player” on the world stage by allowing the Union’s single currency to “play its full role on the international scene.”
A major factor that triggered the EU’s pursuit of these efforts was the US-imposed sanctions against Iran in November 2018 and in June 2019, which caused financial hurdles for several European companies with business ties to the country and limited the EU’s ability to fulfill some of its international engagements.
These restrictions, which exposed the EU’s lack of sovereignty and its failure to protect the interests of its firms from the impact of foreign decisions, has prompted European leaders to rethink the financial framework under which the world economy operates.
In August 2018, Germany’s foreign minister Heiko Maas proposed the creation of a new independent network for monetary transactions, as an alternative to the widely used SWIFT system which opted to abide by the US sanctions and block all financial transfer to and from Iranian banks.
The idea did come to fruition in the form of a collaboration between Germany, France, and the UK to establish The Instrument in Support of Trade Exchanges or INSTEX — a new vehicle for financial exchanges made for the specific purpose of circumventing the US-imposed restrictions.
The new system ultimately failed to meet expectations due to the reluctance of companies to adopt it for fear of alienating the US market or even worse, being excluded from the currently-dollar-dominated financial system.
It did, however, signal the willingness of European countries –or at least the six who joined the initiative– to buck conventional wisdom in order to secure their international investments.
But the European retaliation against the US interfering in its economic affairs went beyond avoiding the traditional international payment channels.
In order to protect the industries of its member nations from both Chinese competition and the volatile decisions of US leadership, the EU has pursued bold measures that preceded and arguably set the stage for the unveiled proposals of January 2021.
In fact, the European Commission’s campaign to promote the use of the euro for international energy-related transactions has been going on behind the scenes since the beginning of 2019.
The push proved to be a monumental success, with Russian oil giant Rosneft announcing its decision to bill all of its exports in euros instead of dollars following a meeting with commission officials in June 2019.
Despite the early triumph, the EU executive arm showed no signs of slowing down; in November 2019, President of the European Commission Ursula von der Leyen gave Kadri Simson, the commissioner for energy, explicit instructions “to look at ways to sharply increase the use of the euro in energy markets”.
In other moves, the European Central Bank (ECB) –a financial institution that operates in all 19 countries of the Eurozone– has been used as a communication tool to point out the economic benefits of the euro having a larger presence in international monetary transfers.
The future of the dollar could be uncertain
The current global situation may provide the EU with favourable conditions to achieve its financial ambitions.
The US dollar, in particular, witnessed a drop in value from an average of 0.9 Euro in the months leading up to the pandemic to approximately 0.82 Euro by the end of 2020, and is at risk of further decline following the change of leadership in Washington DC,
Could this be an opportunity for the Euro to seize on the diminishing power of its US counterpart and impose itself as the global currency of choice for investors?
According to financial experts, the answer is not so easy to determine.
In fact, conflicting opinions have been offered as to whether the economic plan proposed by newly elected leadership in the US would help the dollar recover its lost value or sink it even further.
President Joe Biden, fresh out of his inauguration on January 20, has put forth a so-called “American Rescue Plan”: a $1.9 trillion package aimed at providing immediate aid to Americans struggling due to the COVID-19 pandemic, along with investment in infrastructure, renewable energy, and elsewhere.
The proposal, which comes shortly after a previous $3.4 trillion relief package was put into effect in December 2020, is likely to succeed seeing as the Democratic party controls not just the white house, but also both chambers of Congress.
As result, an ongoing debate was sparked over how these kinds of massive expenditures would affect the value of the almighty dollar.
On one hand, some economists believe that this substantial amount of spending would stimulate the US economy, which in turn would bring investment into the US and lead to even more growth.
They believe that, once the country’s economy bounces back to its pre-pandemic state, the expected inflation would allow the US government to charge higher interest rates, thus bringing in more foreign capital and boosting its currency as a result.
However, other experts have warned that spending additional trillions of dollars will cause the country to accumulate even more debt and further weaken the dollar’s position in the foreign exchange market.
This claim is backed by data from 2020, a year during which the US budget deficit reached an astonishing 115 percent of the country’s economic output during that year.
Overall, the US has accumulated an enormous amount of debt that is projected to reach 134 percent of the country’s 2021 economic output, to which Biden’s plan would add an additional nine percent.
If this estimation turns out to be correct, even without taking the new “American Rescue Plan” spending package into account, the financial situation in the US would be on par with Italy’s prior to the country going into recession.
In fact, not only would the growing debt crisis lead to higher borrowing interest rates that would hamstring economic recovery, but the record-breaking budget shortfall of 2020 will also result in a higher trade deficit, which, along with the US Federal Reserve’s ongoing policy of printing more money, will negatively impact the value of the dollar.
In this context, American economist Stephen Roach, who serves as a senior fellow at Yale University’s Jackson Institute for Global Affairs, has expressed concerns over what the historically high US budget deficit would mean for the future of the country’s economy and its currency.
In an interview conducted by the business news channel CNBC on January 11, 2021, the former chief economist at New York investment bank Morgan Stanley predicted a dip of up to 20 percent in the dollar’s value during 2021 due to the United States’ current financial shortcomings as well as its troubled economy which he described as “slipping right before our very eyes”.
“I do see another 15 to 20% downside to the broad dollar index over the course of this year,” he revealed.
Roach added that the expected dollar devaluation is also a reflection of “the strength of the euro” and a testament to its ability to withstand a global economic crisis.
The dollar decline projected to accompany Biden’s American Rescue Plan may or may not take place in the near future, but the ever-rising US debt will eventually harm the value of the currency, which will probably help the euro reach its goal in the long term.
The rise of digital currency: a potential game-changer
Another factor that could upset the current balance of power in the global financial system is the emergence of virtual money as an alternative to traditional-currency-based transactions.
This relatively new banking technology, which allows users to bypass both the limits imposed by financial institutions and governmental regulations, could revolutionize the entire financial sector: an outcome in which the dollar –currently leading the race for the most used currency worldwide– has the most to lose.
Perhaps the best indication of the threat that digital currency poses to the global financial order is the pushback that Facebook has received from major world leaders following the company’s announcement in May 2019 that it would be developing its own virtual payment system called Libra.
The platform, which is set to launch in 2021, has sent governments into a state of panic, and for good reason.
In fact, experts have warned that the takeover of the financial sector by digital money could happen at a much faster pace than conventional currencies –whose popularity depends on slow economic and trade changes– are able to produce.
However, what certain parties perceive as a threat to their financial stability, others see as an opportunity to break the dependence of their monetary sector on the dollar, and by association the US.
The list of potential partakers includes China, Russia, and even the EU — which stands to benefit the most from a diminishing influence of the dollar over international transactions.
The appeal of this prospect has led groups such as The Association of German Banks to call for digitizing the euro in order to give it a competitive edge over its rival currencies and to avoid the problems that could arise from using another country’s financial services.
The ECB has also been evaluating the prospects of implementing a digital euro that will take advantage of the latest technologies in terms of virtual monetary transactions while still operating under the authority of the ECB and national central banks.
A decision on the future of this project will reportedly be reached towards the middle of 2021.
Conclusion
While the euro overtaking the dollar may be too steep a hill to climb in a global financial system that is so entrenched in the use of the US currency, it will continue to gain ground as long as the EU keeps projecting economic stability and offering incentives to companies and investors who make the switch.
