Europe wonders whether it can afford to take on the US dollar

FRANKFURT — A surging euro is waking up European policymakers to the drawbacks of an ambition they have long cherished: turning the common currency into a reserve currency to rival the U.S. dollar.

The greenback has been the world’s reserve currency since the end of World War II, when it took over from the pound sterling. That special status has meant that it is the currency in which most global trade is conducted and in which governments worldwide hold most of their foreign exchange reserves. That demand has allowed the U.S. government and Americans to borrow cheaply for decades.

The lure of lower borrowing costs, a more stable currency and protection from U.S. sanctions is why European policymakers hold on to the ambition of displacing the dollar. But governments and investors won’t hold the euro unless it is strong and promises to remain so.

And a strong euro — the currency rose above $1.20 for the first time in four years on Tuesday — is already threatening the export-oriented growth model of Europe’s largest economy, Germany.

“I’ve been watching the development of the dollar exchange rate with concern for quite some time,” German Chancellor Friedrich Merz told reporters on Wednesday in Berlin. “The dollar exchange rate is a considerable additional burden for the German export industry.”

ECB President Christine Lagarde raised the prospect of a rare “global euro moment” last summer as cracks began to appear in U.S. dollar dominance. While foreign investors have largely kept faith with the U.S. stock and bond markets, they appear to have been more actively protecting themselves against the risk of a fall in the dollar itself — contributing to the euro's rise in value. 

The greenback still makes up some 57 percent of all global reserves, compared with the euro, in second place at around 20 percent.

“If you want your currency to be a global reserve, you have to accept that it will strengthen,” said Carsten Brzeski, ING’s global head of macro. The logic is simple: The greater the appetite for European assets, the higher the exchange rate with other currencies. “If the ECB sticks by its ‘global euro moment’, it will have to swallow that trade-off.”

Merz’s concern is that a stronger euro will make European exports too expensive for foreign buyers, who’ll look for cheaper goods elsewhere, hurting the EU economy. It also tends to make Chinese imports into Europe cheaper, given that Beijing generally tries to keep its exchange rate with the dollar stable. The euro is close to a 12-year high against the yuan.

Too strong

It’s not just EU governments that are concerned. ECB policymakers are too.

Within hours of the euro breaching $1.20, central bankers began warning they might have to act to prevent the inflation rate from dropping below 2 percent.

“We are closely monitoring this appreciation of the euro,” French central bank chief François Villeroy de Galhau said Wednesday in a social media post on LinkedIn, echoing similar warnings from his Austrian counterpart, Martin Kocher.

“This is one of the factors that will guide our monetary policy and our decisions on interest rates over the coming months,” the Frenchman said.

Europe’s exporters have been in the doldrums for the last couple of years, due to high domestic production costs, cheap Chinese competition and, latterly, to U.S. trade tariffs, which act as a tax on U.S. purchases of eurozone goods. Anything that makes them still more expensive in the world’s most important market would thus come at a particularly bad time.

That’s a high price to pay for an economy such as the eurozone’s, which runs a persistent trade surplus and whose growth in the short term hinges on a favorable exchange rate. Too high a price, according to U.S. Treasury Secretary Scott Bessent.

“I can tell you if the euro hits $1.20, Europeans are going to be squawking that it is too strong; they’re an export economy, so let’s see what happens,” Bessent said in a CNBC interview in July. “They should be careful what they wish for.”