sum up:

f we lost the dollar as the world currency,” Donald Trump told The Economic Club of New York last September, “I think that would be the equivalent of losing a war.” Since beginning his second presidency, Trump has maintained this position, even threatening to punish countries that seek alternatives to the dollar. But his actions tell a very different story.As Barry Eichengreen of the University of California, Berkeley, observes, Trump has been “risking financial stability, imposing tariffs willy-nilly, and antagonizing [America’s] alliance partners.” But the history of pound sterling – the currency around which the international monetary system revolved before the dollar rose to prominence – suggests that he should be doing precisely the opposite.When it comes to financial stability, write Nobel laureate economist Simon Johnson and Erkki Liikanen, a former governor of the Bank of Finland, the US Federal Reserve’s independence is vital. Yet, while Trump “seems to have backed down from his recent threats to fire [Fed Chair Jerome] Powell,” he has “claimed complete control over all measures by the Fed other than those regarding monetary policy.” This is already a concern, because “many regulatory decisions” taken by the Fed “are fundamental to financial stability and therefore to the conduct of monetary policy.”The other two problems Eichengreen highlights – tariffs and geopolitical antagonism – are embodied by the Trump administration’s proposed Mar-a-Lago Accord. As Harold James, Professor of History and International Affairs at Princeton University, points out, the Accord would weaponize both trade and US security assurances, with the express goal of weakening the dollar – a goal that the administration believes it can pursue without “destroy[ing] confidence in the greenback.”Similarly, Harvard’s Kenneth Rogoff argues that the logic underpinning the Mar-a-Lago Accord – that weakening the greenback would reduce America’s current-account deficit – is “based on a deeply flawed understanding of the relationship between the dollar’s global status and US deindustrialization.” In fact, the dollar’s role as the world’s leading reserve currency is just “one of many factors contributing to America’s persistent trade deficits.”But a tarnished greenback creates an opening for others. By sending investors “desperately searching for safe alternatives to US Treasuries,” writes Philippe Legrain, Visiting Senior Fellow at the London School of Economics’ European Institute, Trump’s actions have created an “unprecedented opportunity” for the European Union. A large issuance of common euro-denominated EU bonds, he explains, would “strengthen Europe’s economy, security, and policymaking autonomy.”Similarly, London Business School’s Hélène Rey argues that the eurozone should seize the current moment to “raise the euro’s international profile,” thereby capturing some of the “exorbitant privilege” that the US has long enjoyed – and that Trump is now squandering. If it is to succeed, however, policymakers must take several steps, including deepening the single market in goods and services, completing the banking union and the savings and investment union, and increasing the sovereignty of its own payments system.
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Stefan Wermuth/WPA/Pool/Getty Images
Sterling’s Past and the Dollar’s Future
Apr 10, 2025
Barry Eichengreen

US President Donald Trump says he wants to preserve the dollar's international role as a reserve and payment currency. If that's true, the history of pound sterling suggests he should be promoting financial stability, limiting the use of tariffs, and strengthening America's geopolitical alliances.

TOKYO – In April 1925, a hundred years ago this month, Winston Churchill, in his capacity as chancellor of the exchequer, took the fateful decision to return pound sterling to the gold standard at the prewar rate of exchange. 
Churchill then, not unlike US Treasury Secretary Scott Bessent now, was torn between two objectives. On one hand, he wanted to maintain sterling’s position as the key currency around which the international monetary system revolved, and preserve London’s status as the leading international financial center. On the other hand, he, or at least influential voices around him, saw merit in a more competitive – read “devalued” – exchange rate that might boost British manufacturing and exports. Why Churchill chose the first course is uncertain. The weight of history – British economic preeminence under the gold standard prior to World War I – pointed to restoring the monetary status quo ante. The City of London, meaning the financial sector, lobbied for a return to the prewar exchange rate against gold and the dollar. The most articulate opponent, John Maynard Keynes, had an off night when given an opportunity to make his case to the chancellor. The effects were much as predicted. Sterling regained its position as a key international currency, and the City its position as a financial center. Now, however, they had to contend with New York and the dollar, which had gained importance, owing to disruptions to Europe from the war and the establishment of the Federal Reserve System to backstop US financial markets.  Also as predicted, British exports stagnated. At current prices, they were lower in 1928-29 than in 1924-25, when the decision to stabilize the exchange rate was taken.
Here, clearly, a strong pound and the high interest rates required to defend its exchange rate were unhelpful. But to attribute the British economy’s poor performance entirely to the exchange rate is to jump to conclusions. For one thing, the export industries on which Britain traditionally relied – textiles, steel, and shipbuilding – were now subject to intense competition from later industrializers with more modern facilities, including the United States and Japan. The situation was not unlike the competition currently felt by US manufacturing from China and other emerging markets. Then as now, it is not clear that a weaker exchange rate would have made much difference, given the emergence of these rising powers. Nor did the tariffs the United Kingdom imposed in the 1930s revive its old industries. Moreover, Britain had difficulty developing the new industries that constituted the technological frontier – electrical engineering, motor vehicles, and household consumer durables – even after devaluing the pound in 1931. The US and other countries were quicker to adopt new technologies and production methods, such as the assembly line. Union militancy discouraged investment. Workers with the relevant skills and work ethic were in short supply. Again, these are not unlike complaints heard today from the operators of TSMC’s new semiconductor fab in Arizona or Samsung’s chipmaking plants in Texas. And, of course, it did not help that the 1930s were marked by trade wars and a decade-long depression. Notwithstanding these problems, sterling’s position as an international currency survived the 1930s. In fact, the pound regained some of the ground as a reserve and payments currency that it lost to the dollar in the preceding decades. Whereas Britain was broadly successful in maintaining banking and financial stability, the US suffered three debilitating banking and financial crises. The UK maintained stable trade relations with its Commonwealth and Empire under a system of imperial preference that negated the effects of otherwise restrictive tariffs. And it remained on good terms with trade partners and political allies beyond the Commonwealth and Empire, including in Scandinavia, the Middle East, and the Baltics, where monetary authorities continued to peg their countries’ currencies to sterling. The lessons for those seeking to preserve the dollar’s status as a global currency are clear. Avoid financial instability, which in the current context means not allowing problems in the crypto sphere to spill over to the rest of the banking and financial system. Limit recourse to tariffs, since the dollar’s wide international use derives in substantial part from America’s trade relations with the rest of the world. And preserve the country’s geopolitical alliances, since it is America’s alliance partners who are most likely to see the US as a reliable steward of their foreign assets and hold its currency as a show of good faith. The US, to all appearances, is going down the opposite path, risking financial stability, imposing tariffs willy-nilly, and antagonizing its alliance partners. What was achieved over a long period could be demolished in the blink of an eye – or with the stroke of a president’s pen. Churchill was aware of the risks. As he put it, “To build may have to be the slow and laborious task of years. To destroy can be the thoughtless act of a single day.”
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Kevin Dietsch/Getty Images
Financial Stability Requires an Independent Fed
May 6, 2025
Simon Johnson ,  Erkki Liikanen

In a February executive order, the Trump administration claimed complete control over all measures by the Federal Reserve other than those concerning monetary policy. This is already a concern, because many regulatory decisions are fundamental to financial stability and therefore to the conduct of monetary policy.

WASHINGTON, DC – When US President Richard Nixon appointed Arthur Burns as Federal Reserve Chair in 1970, he welcomed him to the job with these words: “I respect his independence. However, I hope that, independently, he will conclude that my views are the ones that should be followed.”
Nixon’s views were that the economy needed “lower interest rates and more money,” presumably in part because this would help his re-election bid in 1972. And Burns did fall into line, more or less. But the consequences were unfortunate: Fed policy contributed to high inflation, which reached a dangerous and disruptive level by the end of the decade. It took prolonged high interest rates and a deep recession for the Fed to bring inflation back under control. Tensions between central banks and governments are nothing new – and this includes friction between the Federal Reserve System and the President of the United States. Presidents typically want to boost economic growth and want monetary policy to support this goal with lower interest rates. Central bankers, however, also bear responsibility for maintaining price stability and worry that overstimulating the economy for short-term purposes will end in tears. In recent weeks, President Donald Trump has been pressing the Fed to lower short-term interest rates, to help the economy weather the coming storm from higher tariffs and other trade-related disruptions. But, because tariffs raise the price of imported goods, they tend to raise the price level and create the potential for further price increases. Whether the Fed should cut rates remains to be seen, and Fed Chair Jerome Powell and his colleagues are wise to want more data.
How big a hit will the US take to GDP? And how much of an upward shock to inflation is the economy about to encounter? The uncertainties surrounding the Trump administration’s policies make these key variables difficult to predict. In this situation, cutting short-term interest rates could prove counter-productive, because the Fed cannot control long-term rates, such as on ten-year government bonds. If financial markets think that inflation will increase, interest rates will tend to rise on long-term government debt, pulling up long-term interest rates for all potential borrowers across the economy – which will further depress business investment and make it more expensive to buy homes. In the language of central banks, economic growth, job creation, and financial stability are all helped when expectations for annual inflation remain anchored at around 2%. Given the experience during and after the pandemic, these expectations are already under pressure. It would be unwise to allow inflation to surge in the near future. Big movements in long-term interest rates can easily cause problems for financial stability. Liz Truss’s short-lived government in the United Kingdom learned this the hard way in October 2022. The last thing that the US and other economies need now is disruption to bond markets, banks, insurance companies, hedge funds, or any large financial company or activity. Trump seems to have backed down from his recent threats to fire Powell – a détente that, assuming it holds, should help soothe financial markets for a while. But Powell’s term expires in May 2026, and by the end of this year, market participants will want to know what happens next. The president appoints all members of the Fed Board of Governors, including the chair, subject to confirmation by the Senate, and it is entirely within presidents’ authority to pick people they think will be accommodating as policymakers – as Nixon did. The Trump administration has already asserted and achieved an unprecedented degree of centralized control over the executive branch – meaning that all regulatory decisions, no matter how consequential, need approval from the very top. In the February executive order that effectively ended the independence of federal agencies, the administration also claimed complete control over all measures by the Fed other than those regarding monetary policy. This is already a concern, because many regulatory decisions, for example on bank reserves (held on the asset side of banks’ balance sheets) and bank capital (the equity required for banks’ liability side), are fundamental to financial stability and therefore to the conduct of monetary policy. But that expansive February executive order wisely left monetary policy to be decided by the central bank, its appointed officials, and its deep well of experts, who base their decisions on the mandate given to them by Congress. If the administration at any point reverses course and undermines those thoughtful professionals, removes them “for cause,” or otherwise encroaches on their independence, we will all, sooner or later, pay a cost – and perhaps a very high one. The authors are co-chairs of the CFA Institute Systemic Risk Council.
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JuSun/Getty Images
A Mar-a-Lago Accord Could Break the Dollar
May 8, 2025
Harold James

The risk inherent in a "Mar-a-Lago Accord" to orchestrate a dollar depreciation is that the weaponization of trade and US security assurances will destroy confidence in the greenback. Whereas similar previous efforts merely failed, the Trump administration's effort could backfire catastrophically.

PRINCETON – According to US President Donald Trump and his advisers, the international monetary system is broken and works to the disadvantage of Americans. A radical reform is required, and it can probably come only from a highly disruptive reordering of the world.
We have been here before. In 1944, the United States hosted the 44-country Bretton Woods conference, which charted a course out of the dysfunctional order of the interwar period. Now, US Treasury Secretary Scott Bessent regularly conjures the image of a new Bretton Woods moment. The goal would be to deliver a “Mar-a-Lago Accord” that addresses three overlapping, interconnected problems that are not typically lumped together, because they are the business of separate agencies and separate international institutions. The first concerns trade: how to stop the loss of American jobs and livelihoods. The second concerns money: the dollar’s centrality in the global system leaves it overvalued, which makes American exports too expensive. And the third concerns security: the US bears the burden of defending other countries. The Trump administration’s conceit is that US trade and security policies can be used to force others to orchestrate a depreciation of the dollar without destroying its reserve status. The idea of a Mar-a-Lago Accord draws directly on previous occasions when the US took steps to reinvent the international monetary system and bring down the value of the dollar. The most obvious reference point is the December 1971 Smithsonian Agreement, which President Richard Nixon proclaimed was “the most significant monetary agreement in the history of the world.” Another precedent is the September 1985 Plaza Accord under President Ronald Reagan, which probably is the inspiration for the Trump administration’s effort.
In both cases, a US president believed that the dollar was overvalued, that American exporters and workers were disadvantaged, and that US economic policy had been blocked by foreign obstruction. This sense of entrapment created an impetus for radical disruption. Nixon famously concluded that America could force a necessary change if he came across as a madman. His treasury secretary, the larger-than-life Texan John Connally, famously told Europeans: “the dollar is our currency, but it’s your problem.” In each case, the stick with which to beat other countries was trade policy. In 1971, with the dollar’s convertibility into gold suspended, Nixon imposed a 10% surcharge on all imports (the same minimum tariff that Trump announced on April 2). Similarly, in 1985, congressional demands to stem the flood of imports (largely from Japan) gave Treasury Secretary James Baker what he needed to force the rest of the then-G5 developed economies to depreciate their currencies. Bessent is channeling Connally and Baker when he tells reporters that the current tariffs are meant to push other countries toward a new deal. Supposedly, 75 governments are willing to negotiate, and 15 have already proposed a deal. The whole world, Trump claims, is “kissing my ass.” But neither the Smithsonian Agreement nor the Plaza Accord lasted very long. The Smithsonian parities didn’t stick, largely because the US continued a big fiscal expansion that sucked in more imports. Then, when the Europeans, followed by the rest of the world, moved away from fixed exchange rates in 1973, the dollar needed to be depreciated by much more. Similarly, the Plaza Accord was quickly succeeded by the 1987 Louvre Accord, which aimed to stabilize exchange rates; but disputes about how to achieve this goal triggered a major international stock market panic that October. This history augurs poorly for a modern accord. Worse, Trump and many around him genuinely seem to believe that tariffs will raise the revenue they need to make room for the tax cuts they crave. By this reasoning, tariffs cannot be just a negotiating tool; they would have to become a permanent reality. All the talk of a Mar-a-Lago Accord stems from an influential – and now notorious – November 2024 paper by Stephen Miran, “A User’s Guide to Restructuring the Global Trading System,” which probably won him his post as chair of the White House Council of Economic Advisers. After warning about shocks to the real-estate market and the federal budget from rising long-term yields, Miran proposed his grand solution: The US should use its security guarantees as leverage over countries holding dollar assets. This, too, has historical precedents. In the 1960s, the US made it clear to West Germany that its defense against the Soviet threat was contingent on German accommodation of US monetary goals. The same logic had also been applied during the interwar period, when Britain and France, the giants of nineteenth-century finance, held substantial gold reserves. The British and the French encouraged countries on the periphery, especially in central and eastern Europe, to hold a large part of their reserves in British and French short-term deposits and Treasury bills in exchange for security guarantees. But by the 1930s, these smaller states knew that this arrangement was not working, and insisted on holding only gold. Today, it is not only China, Russia, and Turkey that are pumping up their gold reserves; so, too, are those European states that were so vulnerable during the interwar period: Czechia, Hungary, and Poland. The risk inherent in a Mar-a-Lago Accord is that the weaponization of trade and US security assurances to weaken the dollar will destroy confidence in the greenback. An effort supposedly to defend American workers will overshoot, necessitating a new international currency agreement, but with the US no longer commanding the credibility to supply it. We already know that the Smithsonian Agreement and the Plaza Accord brought little long-term relief to US workers. An attempt to replicate them would be ineffective – and possibly wholly destructive.
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Tom Stoddart/Getty Images
Trump’s Misguided Plan to Weaken the Dollar
May 6, 2025
Kenneth Rogoff

The so-called Mar-a-Lago Accord, proposed by Council of Economic Advisers Chair Stephen Miran, aims to reduce the United States’ current-account deficit by weakening the dollar. But this plan is based on a deeply flawed understanding of the relationship between the dollar’s global status and US deindustrialization.

CAMBRIDGE – Now that US President Donald Trump’s tariff war is in full swing, investors around the world are asking: What’s next on his agenda for upending the global economic order? Many are turning their attention to the so-called “Mar-a-Lago Accord” – a plan proposed by Stephen Miran, chair of Trump’s Council of Economic Advisers, to coordinate with America’s trading partners to weaken the dollar.
At the heart of the plan is the notion that the dollar’s status as the world’s reserve currency is not a privilege but a costly burden that has played a major role in the deindustrialization of the American economy. The global demand for dollars, the argument goes, drives up its value, making US-made goods more expensive than imports. That, in turn, leads to persistent trade deficits and incentivizes US manufacturers to move production overseas, taking jobs with them. Is there any truth to this narrative? The answer is both yes and no. It’s certainly plausible that foreign investors eager to hold US stocks, bonds, and real estate could generate a steady flow of capital into the United States, fueling domestic consumption and boosting demand for both tradable goods like cars and non-tradables such as real estate and restaurants. Higher demand for non-tradable goods, in particular, tends to push up the dollar’s value, making imports more attractive to American consumers, just as Miran suggests. But this logic also overlooks crucial details. While the dollar’s reserve-currency status drives up demand for Treasuries, it does not necessarily increase demand for all US assets. Asian central banks, for example, hold trillions of dollars in Treasury bills, which they use to help stabilize their exchange rates and maintain a financial buffer in the event of a crisis. They generally avoid other types of US assets, such as equities and real estate, since these do not serve the same policy objectives.
This means that if foreign countries simply need to accumulate Treasury bills, they don’t have to run trade surpluses to obtain them. The necessary funds can also be raised by selling existing foreign assets such as stocks, real estate, and factories. That is precisely what happened in the 1960s through the mid-1970s. By then, the dollar had firmly established itself as the global reserve currency, yet the US was almost always running a current-account surplus – not a deficit. Foreign investors were accumulating US Treasuries, while American firms expanded abroad by acquiring foreign production facilities, either through direct purchases or “greenfield” investments, in which they built factories from the ground up. The postwar era was hardly the only time when the country issuing the world’s reserve currency ran a current-account surplus. The British pound was the undisputed global reserve currency from the end of the Napoleonic Wars in the early 1800s until the outbreak of World War I in 1914. Throughout that period, the United Kingdom generally ran external surpluses, bolstered by high returns on investments across its colonial empire. There is another way to interpret the US current-account deficit that helps explain why the relationship between the exchange rate and trade imbalances is more complicated than Miran’s theory suggests. In accounting terms, a country’s current-account surplus equals the difference between national savings and investment by both the government and the private sector. Importantly, “investment” here refers to physical assets such as factories, housing, infrastructure, and equipment – not financial instruments. When viewed through this lens, it is clear that the current-account deficit is influenced not just by the exchange rate but by anything that affects the balance between national saving and investment. In 2024, the US fiscal deficit was 6.4% of GDP, significantly larger than the current-account deficit, which was under 4% of GDP. While closing the fiscal deficit would not automatically eliminate the current-account deficit – that would depend on how the gap is closed and how the private sector responds – it is a far more straightforward fix than launching a trade war. Reducing the fiscal deficit would, however, involve the difficult political task of convincing Congress to pass more responsible tax and spending bills. And unlike a high-profile trade confrontation, it wouldn’t cause foreign leaders to curry favor with Trump; instead, it would shift media attention back to domestic politics and congressional negotiations. Another key factor behind the current-account deficit is the strength of the American economy, which has been by far the most dynamic among the world’s major players in recent years. This has made US businesses particularly attractive to investors. Even manufacturing has grown as a share of GDP. The reason employment has not kept pace is that modern factories are highly automated. Miran’s plan, clever as it might be, is based on a flawed diagnosis. While the dollar’s role as the world’s leading reserve currency plays a part, it is just one of many factors contributing to America’s persistent trade deficits. And if the trade deficit has many causes, the idea that tariffs can be a cure-all is dubious at best.
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Daneil Roland/Getty Images
Time for EU Bonds to Shine
Apr 22, 2025
Philippe Legrain

As investors desperately search for safe alternatives to US Treasuries, the European Union has been given an unprecedented opportunity. In addition to satisfying investor demand, a large issuance of common EU bonds would strengthen Europe’s economy, security, and policymaking autonomy.

LONDON – US President Donald Trump’s toxic tariff war is not only threatening the global trading system, but also undermining trust in US government bonds and the dollar. That should alarm everyone, because the global financial system rests on the premise that US Treasury bonds are the safest assets. But investors’ desperate search for alternative safe assets has also given the European Union an unprecedented opportunity. In addition to satisfying growing investor demand, a large issuance of common EU bonds would strengthen Europe’s economy, security, and policymaking autonomy.
The dollar – particularly long-term bonds issued by the US government – has long been the ultimate safe haven. Even when global turmoil originated in the United States, as was true of the 2008 financial crisis, investors have sought refuge in US Treasuries. But everything changed earlier this month. Amid the market mayhem unleashed by US tariffs, investors not only dumped US stocks but also ditched US Treasuries and the dollar, buying gold, Swiss francs, and euros instead. Beyond triggering an economic crisis, Trump’s wildly destructive policies are causing a crisis of confidence in the US itself. While Trump’s partial tariff pause on April 9 stopped the immediate bond-market rout, the situation remains volatile. Once trust erodes, it is not easily regained – especially when there is massive uncertainty about what outrageous blunder Trump will commit next. The US Treasury market is massive, at $28.6 trillion, which means that even a small desire for diversification can create huge demand for euro-denominated safe assets. The second week of April witnessed the largest sell-off of US Treasuries relative to German government bonds since at least the 1980s. Even Italian government bonds, normally seen as a risky bet, have rallied recently. Investors’ appetite for an increased issuance of EU bonds, which typically boast a AAA credit rating, would almost certainly be high.
The EU has already issued around €1.3 trillion ($1.5 trillion) in common debt. Some €620 billion in outstanding EU bonds were issued to fund COVID-19 recovery programs; the European Investment Bank had €420 billion in bonds outstanding last year; and the European Stability Mechanism, the EU’s crisis-lending arm, had an additional €280 billion outstanding (in combination with its predecessor). But the stock of EU debt remains tiny compared to the US Treasury market, and the flow of new bond issuance is relatively low and irregular. Pandemic-related collective EU borrowing was meant to be a one-off program, and the European Commission’s new €150 billion facility to lend to EU governments for joint defense procurement is likewise time-limited. Thus, there is a compelling case for capitalizing on this opportunity to issue many more common bonds, and to roll over existing EU debt as it matures. Doing so would bolster the euro’s international role, boost the EU economy, and help finance a much-needed increase in Europe’s defense spending. European leaders have long resented the “exorbitant privilege” that the dollar confers on America in the global financial system. The fact that US Treasuries have been the premier safe asset for both official-sector reserves and private-sector portfolios has lowered the US government’s borrowing costs, and thus the interest rates paid by riskier US borrowers, too. It has also given US policymakers exceptional freedom of action, not least during crises, when everyone else typically wants dollars. Although the euro is a long way from displacing the greenback, it has the potential to be a more important reserve currency and safe-haven asset. As a geopolitical matter, EU leaders have already endorsed the idea that the euro should play a more important international role. This goal has become urgent now that Trump is wrecking the global order and threatening to use Europe’s dollar dependence against it. As an economic matter, issuing EU bonds would help Europe’s economy in the face of US tariffs and Trump-induced, investment-chilling uncertainty. Since EU exports to the US are poised to shrink, fiscal stimulus may be needed to foster alternative sources of demand. As a security matter, joint EU borrowing would enable Europe to raise hundreds of billions of euros more for its own defense and that of Ukraine, and in a way that does not burden stretched national public finances or require unpopular tax hikes or spending cuts. While Germany has ample borrowing power to increase its defense spending, France, the EU’s most important military power, does not. As a financial matter, a greater issuance of EU bonds would be helpful for eurozone banks whose holdings of domestic government bonds otherwise tie their fate to that of the government that backstops them. This dynamic was the source of the “doom loop” that drove so much of the 2010-12 eurozone crisis. The main objection to issuing common EU debt is, of course, political. Frugal northern European governments have traditionally not wanted to bankroll what they view as southern European profligacy. But Germany and other fiscally conservative governments are now much more open to common EU borrowing, owing to their pressing need to rearm (Berlin is much closer to the Russian border than Rome, Madrid, or Lisbon). Perhaps most importantly, a bold move to issue common bonds would give the EU greater agency. Instead of merely reacting to Trump’s every betrayal and flip-flop, Europeans would be taking control over their own destiny. If not now, when?
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Kirill Kudryavtsev/AFP via Getty Images
Prepare for the Global Euro
May 5, 2025
Hélène Rey

After serving as the world's hegemon for decades, the US appears to be renouncing the role by refusing to supply global public goods and eroding confidence in the dollar. This creates an opportunity for the eurozone to capture some of the exorbitant privilege long enjoyed by the US.

LONDON – International monetary and financial systems may not be immutable, but nor do they change often. That is why the upheaval spurred by US President Donald Trump’s trade and tariff war is so remarkable – and difficult to decipher. To figure out what is going on, it is worth revisiting Charles P. Kindleberger’s theory of hegemonic stability, which he spelled out in his book The World in Depression: 1929-1939. Kindleberger’s theory essentially states that an open and stable international system depends on the presence of a dominant world power.
In the nineteenth century, that power was Britain. As the world’s financial hegemon – leader of the global economic system and issuer of the dominant international currency – Britain supplied critical public goods. These included, as Kindleberger put it, a “market for distress goods, provided by British free trade,” and a countercyclical flow of capital, produced by the City of London. Britain also supported “coordination of macroeconomic policies and exchange rates,” through the “rules of the gold standard,” which were “legitimized and institutionalized by usage.” Finally, the Bank of England served as a “lender of last resort.” But World War I took its toll on Great Britain, which by the 1930s no longer had sufficient resources to underpin the international monetary system. And though the United States was an ascending power, it was not yet ready to fill Britain’s shoes. This “Kindleberger gap” – the period between world hegemons – coincided with the Great Depression and the escalating political turmoil that culminated in World War II. Near the end of the war, in 1944, delegates from 44 countries met in Bretton Woods, New Hampshire, where they orchestrated a smooth transition between the old and the new hegemons. In doing so, they validated the de facto supremacy of US trading, financial, and military power. At the time, the US accounted for 35% of world GDP. But though America’s share of global GDP has declined, the US dollar has retained its dominance as a reserve asset, invoicing currency, and anchor for fixed exchange rates. Moreover, the US Federal Reserve’s policy decisions and the US economy’s performance still shape the global financial cycle.
Nonetheless, we seem to be approaching a new “Kindleberger gap.” The existing hegemon appears to be self-destructing, as it refuses to supply global public goods, and there is no clear candidate to fill its shoes. The European Union is not prepared to take up the mantle, and China is not even integrated into global financial markets. Whereas the rest of the world views the dollar’s primacy as an “exorbitant privilege,” the Trump administration appears convinced that global demand for dollar assets is a burden, as it believes it drives up the currency’s value. But if the US continues on its current policy trajectory, it will soon be “relieved” of this burden, whether it likes it or not. If a currency is to serve an international role, the country issuing it generally needs to enjoy economic preeminence and occupy a central position in global trade. These qualities depend on innovative capabilities and growth potential, with military power and geopolitical alliances also playing a role. None of this is possible without an open economy and high-quality, stable institutions. By pursuing policies that undermine US institutions, fundamental research, multilateralism, and the economy’s long-run growth prospects, the US under Trump is rapidly eroding trust in the dollar. Never has this been more apparent than in the wake of Trump’s announcement, in early April, of ultra-high tariffs on goods from dozens of countries running bilateral trade surpluses. US Treasury yields rose, the US stock market fell, and the dollar depreciated – a combination often seen in emerging economies. The economic and financial distress Trump initiated in the US creates an opportunity for the eurozone – which issues the world’s second-most-important international currency – to capture some of the exorbitant privilege long enjoyed by the US. This includes cheaper capital for eurozone governments and businesses – which could support fiscal sustainability – and easier refinancing during times of crises, since demand for “safe” euro assets would rise. It also includes increased geopolitical clout – crucial at a moment when the EU is working to achieve strategic autonomy. While internationalization does carry risks, the eurozone is well-positioned to mitigate them. For example, the eurozone’s macroprudential policy frameworks, which are much stronger than those in the US, can help it cope with increased capital-flow and asset-price volatility. Europe also boasts powerful institutions, starting with the European Central Bank, and a robust rule of law. But more must be done to enable the eurozone to raise the euro’s international profile. For starters, the eurozone must deepen its single market in goods and services, and strengthen its trade relationships wherever possible. Given Europe’s global climate leadership, it could consider starting to invoice climate-friendly products – such as decarbonized energy equipment, electric vehicles, and commodities used in electrification – in euros, while building up corresponding financial instruments (such as those linked to hedging climate risk). The eurozone should also commit to completing the banking union and the savings and investment union, as spelled out in multiple recent policy reports. To deliver deep and integrated capital markets – crucial for innovation and growth – efforts should be made to deliver a true eurozone-wide safe asset. Joint debt issuance for emergency defense spending could be a good starting point. Moreover, rather than allowing eurozone payments to remain largely dependent on US payment systems, the bloc must increase the sovereignty of its own. This would probably rely on a central bank digital currency (CBDC), complemented with a robust payment system that may or may not involve euro stablecoins. Finally, the ECB’s function as lender of last resort must be carefully structured, so as to ensure widespread and strong confidence in the euro. These changes will not be easy to implement. But if Kindleberger taught us anything, it is that the world economy will be better off if, as America retreats from global economic and financial leadership, Europe steps quickly into the breach.