The buck stops here: will Trump kill the dollar?

For anyone who has seen people, companies or even governments battling to fend off the inevitable financial collapse, this speaks volumes. The battle may be long and drawn out, but the end is always very swift. But now compare Hemingway with this:

“History teaches us that regimes seem enduring — until they no longer are.”

Not, as you might suppose, the thoughts of Gibbon in The Decline and Fall of the Roman Empire, or even Shirer in The Rise and Fall of the Third Reich. They are the words of Christine Lagarde, president of the European Central Bank writing in the Financial Times, on the possible fall of the dollar as the world’s leading currency and its reserve currency, and on the chances of it being replaced by the Euro. 

It is a truly amazing piece for someone of Lagarde’s stature to write. A few years ago, it would have been ridiculed. The dollar’s status was not in any real doubt; the US government was happy in the knowledge that it gained almost unimaginable power and wealth from the dollar being the currency of the world’s trading system and the emergency refuge for any investors, anywhere, in time of trouble. 

Now Donald Trump is busy throwing that away – not just through his plans to borrow ever more money to fund tax cuts for the ultra-rich, but by casting doubt on the future independence of the Federal Reserve and undermining confidence that his government is willing to take the responsibilities of running the reserve currency seriously. Increasing numbers of investors, governments, businesses and companies no longer trust Trump or his nodding-dog  administration. 

Just this week, the president openly questioned whether he would not be a better head of the Federal Reserve than the incumbent. Trump claimed he would do a “much better job” running the Federal Reserve than “stupid” Jerome Powell, boasting “maybe I should go to the Fed” when Powell’s term expires next year. He asked;  “Am I allowed to appoint myself at the Fed? I’d do a much better job than these people”. 

To be clear, no president or ever serious politician I have ever heard of has suggested the White House should run the Central Bank too, let alone that the president should chair it, I can’t even think of a Third World dictatorship that does that. 

It used to be a convention that political criticism of the Federal Reserve was muted, restrained and normally reserved for a private off-the-record conversation. The bank’s independence was too vital to risk for any short-term political advantage, that tacit convention is dead and with it much of the vaunted independence of the Fed.  

This and many other factors – including tariff wars which almost invite other countries not to use the greenback, doubts over Trump’s support for America’s allies, his threats to invade neighbours and his demands for financial paybacks for American support – are all slowly undermining faith in the dollar. 

The buck still enjoys huge advantages. Some 58% of global foreign exchange reserves are dollars, it is the currency of a vast united, dynamic economy, of world trade including oil and gas and commodity trading, based in the most powerful country in the world by far. It is supported by the most important central bank in the world, and is based in the home of the largest and most liquid financial markets in the world. It is also the beneficiary of the global post-WWII economic order, which was specifically built around the dollar.

The euro makes up just 20% of foreign exchange reserves and it has few of those other advantages. But then that is what Madame Lagarde was addressing in her article for the FT. Because things change very quickly, now Trump has put the skids under the dollar it is no longer unimaginable that it could be dethroned. 

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But for that to happen the EU needs to change and change a great deal. Luckily Lagarde lays out exactly what might be needed, under three headings:

Geopolitical credibility, economic resilience and legal and institutional integrity.

Geopolitical resilience is already happening in the EU. In part because it just looks more reliable than the USA these days, which is not hard to do. The EU just needs to keep on keeping its word and honouring its treaties, not something you can trust Trump to do from one day to the next, and it will continue to look more trustworthy in comparison. 

Economic resilience is more difficult because the EU is actually quite slow and bad at developing its advantages. The single market needs extending, it is very weak in the services sector when that is by far the largest part of the economy. It also needs “strong growth, to attract investment; deep and liquid capital markets, to support large transactions; and an ample supply of safe assets”. 

The EU’s capital markets in particular are divided, insular and nation- based. Many countries, including Germany, have fought the idea of a single bond market where all countries borrow together, although the latest defence borrowing plan is a step in the right direction. But one European bond market might rival America’s, allow for far more European business giants to emerge and provide assets that would attract safe haven investors much more easily. 

Of course, the great irony is that the obvious place to do that would have been London, but not after Brexit – we are mere spectators in any battle to become the world’s leading currency.

Finally, as the President of the ECB makes clear, the EU needs much more political cooperation and consensus if its currency is to challenge the dollar. The national veto needs to go and there needs to be many more majority decisions. But even so, the EU has one huge advantage: “Respect for the rule of law and the independence of key institutions, like the ECB, are critical comparative advantages the EU should leverage”

Ouch! That is as good as saying central bank independence is no longer a given in the United States. Even if Trump does not make himself chair of the Federal Reserve, surely he will now find a forelock-tugging, grovelling lackey to do his bidding.

Nor is respect for the law in the US now guaranteed. These two essential factors which allow a nation to be taken seriously and to enjoy the confidence of other players have been thrown away deliberately with no idea of the consequences. 

Europe’s institutions are increasingly stronger, more independent and safer than America’s. Until Trump’s second term, that claim would have been unimaginable; now it is common knowledge, and a dagger pointed at the heart of the USA’s economic power. 

In the 1960s, France’s then minister of finance Valery Giscard d’Estaing coined the term “exorbitant privilege” to describe the massive advantage that America enjoyed because its currency was the global reserve currency. It allows America to run huge trade and budget deficits, supporting its living standards and low taxes, and it has done so for 80 years. 

But great power comes with great responsibility – like supporting allies in times of danger or offering unlimited dollars to friends that need them during economic crises. Yet Trump is busy destroying those aspects of noblesse oblige. He does not even acknowledge that they exist, he wants paying up front for everything and is dumb enough to think none of this will undermine his country’s “exorbitant privilege.” 

The very fact that the head of the ECB now says, “This moment of change is an opportunity for Europe: it is a “global euro moment” should terrify anyone who can read in Washington. 

The EU is looking to seize America’s crown because the regime is too wrong-headed to realise that much of its wealth and power is based on the dollar being top dog. 

The defenestration of the dollar won’t happen today or tomorrow, in fact it can’t happen if and until the EU has reformed and developed enough to take advantage of American weakness. But that may come about one day soon and if it does, America will suffer –  “Gradually and then suddenly.”