Trump, the dollar and the geopolitics of the euro

In the chessboard of world currencies Trump, the dollar and the euro geopolitics are like three dominoes: the moves of the first one will determine the fates of the other two. For the ECB, this can be an opportunity to develop the euro's role as an international currency. Provided that the entire European architecture, and its politicians, rise to the occasion.

In the aftermath of the start of Donald Trump's second term as President of the United States, the spotlight has turned on the outlook for the dollar, with the ensuing repercussions on the world economy. From the point of view of economic analysis, the dollar is appreciating strongly today. The reflections on the euro? The depreciation of our currency means an increase in inflation risks. This is an eventuality that Frankfurt is well aware of, but not worried about. In the minutes of the last ECB meeting in October, there were over eight thousand words, but 'dollar' appears only once.

But: the longer the forecasting horizon, the greater the uncertainty. Above all, it becomes crucial to consider the structural analysis: how will the monetary blocs that dominate real and financial exchanges today evolve?

The starting point is, as always, data. A 2022 analysis by economists from the Monetary Fund confirms that, despite the growth of the Chinese renmimbi, the two prevailing currency blocs are still the dollar and the euro, with the former significantly more important than the latter. Using the amount of official foreign exchange reserves of central banks as a yardstick, the dollar and euro reserves account for 61% and 21% of those reserves, respectively.

Moreover, the same analysis highlights that the relative weight of each currency depends on at least four factors, the relevance of which may change from time to time. Thus there is a size factor, an inertial factor, a credibility factor, and a currency activism factor. A currency will be the more international currency the more it represents a country or region whose economic size, as well as in world trade, is relevant. Then there is inertia, as changes in the composition of official reserves hardly happen overnight. Furthermore, it is crucial that the country issuing the currency is credible in terms of political and economic stability. Finally, there is the degree of activism that the governments and central bank of that country show in promoting the role of their currency as a means of international payment.