Will the Dollar’s Loss be the Euro’s Gain?

My lecture will be based on the book and some research papers which I’m proud of: Rogoff & Yuanchen (2024), Pappada & Rogoff (2025), Graf-von-Luckner et al (2023), Ilzetski, Reinhart and Rogoff (2021) and others.

I often get asked, “if not the dollar, what else?” I think the right way to look at this is: “what is the market share of the dollar and how much it might shrink in the coming years?” Based on the work with Carmen Reinhart and Ethan Ilzetski (2021), I argue that this share peaked in 2015 (based on our all-encompassing measure that looks at how central banks manage their exchange rates). Introduction of tariffs by Trump accelerated the decline of the dollar’s share in international reserves but I was concerned about macroeconomic policies of both candidates in last year’s US elections. 

The euro is unlikely to pass the dollar but it is likely to gain market share because there is a lot of trade between Europe and Latin America, Europe and Asia, and also because the dollar has weakened.

A part of becoming a global currency is building up military capacity, being a geopolitical power. Christine Lagarde in her recent speech also said that building up military power is essential to making the euro the global currency. 

I wrote the book because I was frustrated by economists looking only at short-term trends and pretending these trends would last forever. For example, some economists talked a lot about “secular stagnation”, i.e. that interest rates would never go up again after they fell to zero during the 2008 global financial crisis. I never believed that because if you look at history, real interest rates are very volatile: for example, they were zero in the 1930s and then increased. Another example is the belief that China would grow forever. I have papers about the Chinese housing market showing this was not the case. 

Dollar is another example. The idea that the dollar would become more and more powerful just because it is efficient to have a single currency is silly. There are lots of reasons this hasn’t happened over time. The dollar was starting to become very important in the late 1920s, when it pulled ahead of the pound, but then the US defaulted on its debt in 1933 (the US president said that the price of gold would be $35 per ounce instead of $20 per ounce which essentially was a default). After that the share of dollars in international reserves fell from 60% to 20% fairly quickly. 

This share increased again when the Bretton-Woods system was introduced after WWII. The dollar was at the center of this “global system” with other countries of the system (Europe, Japan, Canada) pegging their exchange rates to the dollar. To do this, they had to hold very large amounts of dollars in their reserves. Thus, the share of dollars in reserves eventually reached levels that Asian countries have today, amounting to trillions of dollars. At that time the US promised to exchange dollars for gold if countries asked for it. That system was not sustainable because the US gold supply was limited. As Europe and Japan were growing very fast, the US printed a lot of dollars, but eventually it ran out of gold to back these dollars. 

In 1971, US president Nixon said that you can no longer exchange dollars for gold. Everyone was furious, but the secretary of Treasury John Connelly (quite arrogantly) said to Europeans: “It’s our dollar but it’s your problem.” At that time we hadn’t yet invented the idea of an independent central bank and inflation targeting. Thus, we had inflation for a long time (during 1971-1981 inflation in the US was on average at 8.2% per year – ed.), and between 1971 and 1985 the share of the dollar in reserves fell from 70% to 50%. 

In 1971 the US lost Europe, and it never came back to the dollar. Today, after Donald Trump’s “liberation day”, China is certainly going to delink from the dollar as well. This has already been happening, but now it will happen much faster. China is well aware of what the world did to Russians. China considers sanctions and freezing of Russia’s central bank assets and it is taking steps to move away from the dollar (China has about 2 trillion USD assets). Europe is not very happy with the status quo either because it gives the US too much power. 

Furthermore, the US fiscal deficit is unsustainable. Since interest rates have not declined (contrary to common predictions) the US interest payments on its government debt increased from a few hundred billion dollars 2.5 years ago to about a trillion dollars today. Now they exceed our defense spending and continue to rise. They will rise even if interest rates stay constant as the US rolls over debt, increasing the vulnerability of the US economy.

What will happen to the renminbi in the next ten years will very much resemble what happened to Europe after Nixon. Renminbi will not become an international currency as the Euro hasn’t. But it is going to be a regional currency in Asia — and Asia is huge, so it is potentially a big deal. 

The euro will benefit too as people move away from the dollar. How can Europe help this process? First and foremost they need a capital markets union, an integrated bond market. For this, several things are needed. First, a common bankruptcy law so that companies can sell their bonds in many EU countries, and their creditors are not discriminated. Second, the EU needs to issue Eurobonds. As Olivier Blanchard suggests in his recent paper, the EU should convert a significant amount — 25% of European debts — into Eurobonds to create liquidity in its bond market (about 15 years ago Bruegel had the same idea suggesting to convert 60% of the debt, which is too much). One of the things that make the dollar so potent is the huge liquidity of the US markets. Third, the EU would win from the common fiscal policy. To have it, the EU parliament has to do more than just pass regulations – it will need to have some fiscal power. It is also absolutely necessary to remilitarize Europe. 

American voters want Europe to do more for its defense. Cutting the US defense budget is on the agenda of both Republicans and Democrats. The US needs to cover the Middle East, Taiwan, South China sea, so it does not have capacity to also cover Europe. Europe should be able to defend itself, and in the next few years it should spend on defense much more than 2% of GDP to make up for years of deferred investment into defense and R&D. On the bright side, since this has to be done anyway, it will have a positive impact on the euro as an international currency. If Europe is able to defend itself, the euro will be perceived as a safer currency, and countries that have security agreements with Europe, like Ukraine, will be more likely to hold reserves in euro. 

The big thing is that military power gives the US disproportionate ability to set the rules of the game. Trump often uses the argument that “if you don’t abide, maybe we will not defend you anymore.” However, the US has done this for years, for example, both Richard Nixon and Lindon Johnson used this negotiation tactic as well. 

Having a reserve currency provides many benefits, e.g. being able to impose sanctions or to get lower interest rates, but there is a military cost to that. At the US senate discussions we often hear that thanks to our strong military we are getting lower interest rates and a stronger dollar. It’s a lot of money — about 0.5-1% of total outstanding debt, and it’s of the same order of magnitude as our military spending. There is potential room for Europe to share both spending and benefits of military might. 

I’m not trying to say that the dollar is going out of business. Rather, we are moving towards a tri-polar system where the dollar may remain in the first place, but its share will decline (cryptocurrency in the underground economy may become the fourth pole). 

The reason for this exceptional role of the dollar is not only that the US is a strong economy but also that we have been lucky in many ways. For example, we were lucky that the USSR managed itself as badly as it did and has not become like China. Certainly we were lucky with Japan. In the late 1980s Japan’s stock market and housing stock were worth more than those of the US. But Japan made some huge mistakes, the largest of which was agreeing to swift deregulation and appreciation of their currency. We were also lucky that Europe prematurely admitted Greece to the Eurozone which resulted in a severe crisis. China has made some wrong choices too: they are in hot water now. However, today it feels like our institutions are under assault, therefore this is an opportunity for Europe. 

Europe is moving way ahead of the US in having a central bank digital currency (and Ukraine is quite advanced in digitalization too), while the US is not even trying to catch up. Europe and China are discussing how they can internationalize their digital currencies to process payments. It is a completely separate mechanism for doing transactions outside the eyes of US authorities. And it’s not just about the denomination of transactions but also about their execution, information exchange etc. 

Eventually Ukraine will switch from the current “dollar bloc” to the “euro bloc” because it is in Europe, and the majority of its trade is with Europe. However, you need to pick the right time for this switch in order not to undermine people’s trust in the government. For example, you may want to switch when Europe provides a large sum of money to Ukraine for post-war reconstruction. 

What do you think of frozen Russian assets?

Europe should just give Ukraine money and then resolve this issue when some peace agreement is signed (hopefully when Russia is defeated). $300 billion is not a large sum for Europe (or the US) and Ukraine needs this money now. It is a better decision than giving Ukraine Russian money and then may be having to compensate Russia if it wins the lawsuit. 

How would possible passage of the Big Beautiful Bill and the possible firing of the Fed chair affect the euro?

During his campaign Trump often talked about Biden running huge deficits and thus causing inflation. Indeed, in 2024 the US had a deficit of 6.4% of GDP — a record in peacetime, excluding 2008 and 2020. Trump is almost certainly going to exceed this number: under the most modest assumptions his deficit is going to be 7% of GDP. 

In the US, the central bank is a convention, it is not in the Constitution. If Congress agreed, we could eliminate the Fed in a week and bring it under the Treasury (by the way, in the 1980s almost all the central banks were under Treasuries or Finance Ministries of their countries and from the accounting point of view, a central bank is a unit of the Treasury). 

Trump can cut the Fed’s budget even more easily than he cut Harvard’s budget. He can also add members to the Federal Reserve in the same spirit as Franklin Roosevelt threatened to add members to our Supreme Court in the 1930s because the Supreme Court was about to rule that the government had defaulted on its debt. If the US is under stress, both Trump and Harris would subjugate the Fed. In my book I predicted that the US would have a spike in inflation in 5-7 years. After the “liberation day” I would say it is 4-5 years. It’s a worrisome situation but an opportunity for the euro.