STwenty-one years after its launch in 1999, the euro should now have found a credible reserve currency to challenge the dominance of the US dollar.
Its failure to do so has as much to do with its inherent, as yet unresolved weaknesses, as anything the US authorities have done in seeking to preserve the unique dominance of the US dollar. On the contrary, the Trump administration has militarized the dollar to such an extent that if a credible alternative had been available, the dollar’s days might have been numbered. Unfortunately for international investors, the dollar remains unchallenged as the only universal safe haven of choice, due to the depth of its liquidity pool.
The pandemic amplifies the weaknesses of the euro
EU leaders have so far done little to correct the flaws inherent in the construction of the single currency, flaws that have become increasingly evident in the wake of the coronavirus pandemic, which burned down a trail of economic destruction across the continent, causing enormous economic hardship in weaker parts of the EU, notably Italy, Spain and Greece.
The inability of EU leaders to unite around a single budget response to help weaker members is not better illustrated by the time it took to adopt the pandemic stimulus fund of 750 billion euros agreed by EU leaders this summer. The deal was hailed as a ‘Hamilton moment’ for the EU, with French President Macron saying the deal was a major breakthrough and a ‘profound transformation’, and exactly what the EU and the single market needed to stay consistent. This certainly would have been the case if the deal had been promulgated quickly and in a timely manner, and if it were also much more important given the scale of the task of economic recovery facing countries like Italy. , Spain and Greece.
We hear a lot about shared values and the unity of the European project; However, these types of self-congratulatory statements probably seem rather empty to the millions of unemployed older and younger people across southern Europe, who want something more than sound bites of their elected officials, especially now as a result. a second wave of virus cases. , hospitalizations and deaths. Unfortunately, such statements are all too typical of the myopia that surrounds EU policymakers, as they continue to show little appetite for the kinds of reforms needed to make the euro function as a true currency area. should.
While a change in US president may signal a change in US policy by using the greenback as leverage in its foreign and trade policy, it has never been more important for EU policymakers to build confidence in the single currency, at a time when China continues to seek to assert its economic domination. Due to this inability to reform the euro’s fiscal framework, there has been a reluctance on the part of international investors to use the euro in preference to the US dollar, meaning that although it has been used for more At 21, it only represents 21% of the world’s foreign exchange reserves, compared to 60% for the US dollar. This figure is actually lower than its 2009 peak when it represented over 27% of global foreign exchange reserves, which is hardly a vote of confidence.
This still makes it the second most used currency in the world, but until it corrects its flaws of having 19 different countries using the same interest rate, without a single fiscal policy, it will continue to have doubts. on its viability. This would require European leaders to force closer economic integration at a time when populism is on the rise and more and more people are unhappy with the effects of globalization.
The rise of populism across the bloc continues to be a huge challenge, but it has nothing to do with the challenges posed by Covid-19. Limits on providing large-scale budget support at the EU level have sparked resentment in countries worst hit by the virus, as Italy and Spain grapple with spike in rates mortality, while EU leaders bicker over the gaps between grants and loans. In the absence of political authority or a single treasury, the euro is likely to continue to cause difficulties, especially when it comes to driving reforms, which a number of European politicians have started to do. recognize belatedly, but have so far been completely unable to achieve.
New ECB President needs creative solutions
The appointment of Christine Lagarde as President of the European Central Bank appears to be an integral part of a new strategy to foster closer fiscal integration, but even before she took office, battle lines were drawn by France , Germany and the Netherlands on the harmonization front. It is quite obvious that the negative interest rate policy has done more harm than good, and as such the ECB will need to be even more creative than it has already been this year to help any recovery. economic in 2021, as well as to ensure that it does not. no longer damages the margins of the banking system.
He’s certainly not going anywhere on the monetary policy front and has relaunched his asset purchase program, extending it to € 1.35 billion until the middle of next year in June, then by extending it again by an additional 500 billion euros to 1.85 billion euros. months, until March 2022.
While this helps to save time, with the new lending programs in the form of TLTROs the ECB cannot act on its own. It needs aid on a much larger budget scale, which at the moment only comes in a fairly limited form in the form of the EU stimulus fund, and only 390 billion euros out of the 750 billion euros of this fund are in the form of grants. , way too low to really make a difference
We are finally seeing a large-scale fiscal stimulus at the national level, with Germany leading the way with the temporary suspension of the fiscal compact. However, this stimulus is delivered in a very localized way, rather than on a global basis. European level, with Italy, Spain and Greece who need it most economically. With the damage from the pandemic likely to extend into 2021, Europe really needs to pull itself together, otherwise new economic schisms could open up further over the next 12 months.
The euro must “ grow ”
The euro should simply have grown now and while very few expect it to fall apart at the seam, there is a risk in the absence of significant reforms that it will struggle to even come close to the euro. US dollar in the coming years. , unless doubts about its sustainability are resolved once and for all.
In terms of monetary policy, the ECB is already close to the lower bound due to concerns about the effects of negative rates. That’s not to say that rates can’t go much lower, or that the ECB can’t do more quantitative easing, despite the prospect of a US rate cut, but it limits the hike. And the last thing Europe needs now is a stronger currency, given that it has risen against the dollar over the past 12 months, from 1.0700, and inflation has fallen further. .
Annual performance of EUR / USD 2020
Source: CMC Markets
In the last 12 months we have gone from 1.1100 and have now started to move to the 1.2000 level, and although we saw a brief and welcome drop to 1.0700, it has not lasted, and since then the weakness of United States. dollar has seen the euro gain steadily over the past nine months. To be clear, it was not about the strength of the euro, but rather the weakness of the US dollar. If this continues, the ECB will find it very difficult to push this back and bring inflation back to target.
We can already say that ECB policymakers are worried about this, with ECB Chief Economist Philip Lane constantly talking about the decline whenever it approaches the 1.2000 level, but all they can do is slow down any progress, not stop it completely, with the recent move above 1.2000 testifying to this fact.
The real concern now is that further gains towards 1.2500 will make the ECB’s job even more difficult than it already is, and the lack of political capacity to contribute will only make matters worse.
More than 10 years after the financial crisis, there is still no banking union, no treaty on the European Stability Mechanism, and it now has to face a new economic and health crisis, the tastes of which will still test the more its cohesion in the weeks and months to come.
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