Could an Internationalized Digital Euro Threaten the Dollar?

A digital euro isn’t going to replace the United States dollar as the world’s reserve currency and leading international payments currency anytime soon. But it could help weaken it, or even speed its demise.

That’s one thing to take away from European Central Bank (ECB) President Christine Lagarde’s comment after a summit Wednesday (Sept. 28) on U.S.-European geoeconomics.

Noting that a digital euro could well be more popular outside of the EU, Lagarde said a European central bank digital currency (CBDC) should be “borderless” and could “facilitate cross-border payments in a big way,” CoinDesk reported.

The European Commission has made boosting “the euro’s use outside the euro area, which has stagnated for years and declined slightly in 2020 as a result of the coronavirus pandemic,” a goal, Reuters reported in June 2021. That led the ECB to argue at the time that “a digital euro could boost the single currency’s international status by making it easier to use for paying or saving.”

The Reuters report also pointed to a widely quoted statistic noting that about 22% of global foreign reserves were held in euros in 2020, compared with 59% in U.S. dollars.

Likewise, almost half of all cross-border bank loans are denominated in dollars, compared to the euro’s share of one-third — leaving 20% for the rest of the world, Professor Mark Copelovitch, director of European Studies at the University of Wisconsin at Madison, said in a June column in The Washington Post.

So, it isn’t exactly an immediate threat.

And yet while Lagarde was talking about the need for U.S.-EU cooperation on CBDCs, a digital euro could play into a lessening of U.S. international economic influence and power over global trade finance that has been a goal of China for many years; its Belt and Road Initiative will be a decade old next year.

The World’s Reserve

Protecting the dollar’s status as the world’s reserve currency, and the financial and political power that comes with it, remains a bipartisan concern in Washington.

“Today, the U.S. dollar is the most widely used currency in the world, serving as the basis of financial contracts for all types of business transactions, which translates to American consumers as lower prices for goods and services,” House Financial Services Committee Chairwoman Maxine Waters said in January. “But its role as the world’s reserve currency is under threat by emerging powers like China that are creating their own CBDCs. … [P]olicymakers and regulators must make sure that neither foreign governments’ digital currencies nor digital assets issued by private entities weaken the U.S. dollar’s stature or harm our economy.”

And, indeed, the dollar is a lot harder to dethrone than political pronouncements may make it seem.

In June 2020, a European Parliament report, pointed out that once “a sufficiently large number of market players accept a given currency or monetary standard, others would join this choice because, otherwise, they would risk higher transaction and operational costs.”

It is, the report noted, why commodities trading is dollar based. And the world’s reserve currency has only shifted once in the last two centuries, when the British pound lost the position it held since the 19th century to the U.S. But that took World Wars I and II to accomplish.

Yet the dollar’s role in international payments is not quite as solid, even though it has “the depth and liquidity of U.S. financial markets, the size and openness of the U.S. economy, and international trust in U.S. institutions and rule of law,” as the Federal Reserve noted in its January CBDC report, “Money and Payments: The U.S. Dollar in the Age of Digital Transformation.”

The report also warned that the “implications of a potential future state in which many foreign countries and currency unions may have introduced CBDCs,” must be taken into account. “Some have suggested that, if these new CBDCs were more attractive than existing forms of the U.S. dollar, global use of the dollar could decrease” without a U.S. digital dollar.

The Weaponized Dollar

Another factor that may push countries into cross-border payments and to look for other reserve currencies is the success of U.S.-led sanctions against Russia over its war in Ukraine.

“These sanctions have essentially cut Russia off from the international monetary system,” tech investor Michael Sung and Christopher Thomas, a nonresident senior fellow in foreign policy at the Brookings Institution wrote in a TechStream column in March. “Other nations may view the ability of the United States and its allies to impose these types of sanctions as unsettling and invest in alternatives to the existing dollar-dominated, U.S.-controlled financial system. The result may be a loss of confidence in SWIFT and traditional financial ecosystems, accelerating the pivot to emerging digital currencies.”

That same month, Bloomberg quoted Dylan Grice, a former Société Générale strategist and founder of Calderwood Capital, warning that “weaponization” of the dollar is a card you only get to play once. The sanctions, he predicted, are “a turning point in monetary history.”

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