Probably the most under-reported economic story of our time is the strong appreciation of the euro against the dollar. While the Bitcoin prices rose 26% in dollar terms this year, it was up only 13% in euros.
People fret about Donald Trump’s tariffs, but the exchange-rate supercharges the tariffs. If a US buyer imported a product from the EU at a cost of $1.03 at the beginning of the year, it now costs $1.16 net of tariffs.
Add a 10% tariff, and you are at $1.28. If the tariff were 30%, the rate determined by Trump to take effect August 1, the price goes up to $1.47. That’s almost 50% up on the year.
And for the Europeans it gets worse.
Because China has soft-pegged the renminbi to the dollar, the EU is hit by a double-whammy exchange rate shock from its two most important trading partners.
After Trump imposed his tariff on China, Chinese goods started flooding the European markets in April and May. Because of Chinese dominance of rare earths, there is only so much the Europeans can do about this. If they hit the Chinese too hard, Beijing will cut them off from essential supplies for their industries.
‘Seismic shift’
What’s happening is a seismic shift in US economic policy similar to what happened in 1971.
President Richard Nixon’s “new economic policy” included a 10% unilateral tariff on imports, a 10% cut in US foreign aid, and the dollar’s withdrawal from the Bretton Woods system of semi-fixed exchange rate.
The parallels are almost one-to-one. After the US extricated itself from Bretton Woods, the dollar depreciated.
The Europeans, and the Germans in particular, protested, but there was nothing they could do about it. Again, it looks like history repeating itself.
The brain behind the 1971 operation was not Nixon himself, but his treasury secretary, John Connally. And this is the main difference to today where the driving force is the president.
What is also different is that the trading partners, and especially Europe, are in a more vulnerable position. Germany is more reliant on exports for economic growth than it was back then. It has a higher trade surplus against the rest of the world, and especially against the US.
Trump’s policies pose an existential threat for them. And for the EU as well, since their economic model critically depends on Germany.
Recalibrating the world economy
The Europeans could have put themselves in a more advantageous position, had they created a fiscal and capital markets union alongside the euro.
That would have the euro on a trajectory where it could one day take over from the dollar as the world’s leading global currency.
But instead, EU member states chose to prioritise national fiscal sovereignty. The Europeans did not prepare themselves for a financial world without the support of the US.
While all eyes are focused on the tariffs, the dollar devaluation is the far more consequential part of the policy. My expectation is that we are only at the beginning of this change as the US is losing the safe-haven status for global investors.
All the evidence so far points that Trump pursues dollar devaluation on purpose. Section 899 of his One Big Beautiful Bill would have been a revenge wealth tax on global investors.
It has now been removed. But ask yourself: why did they put this clause into the bill in the first place? Why is Trump taking every opportunity to insult Jeremy Powell, the chair of the Federal Reserve? Why does he keep calling on the Fed to cut rates by hundreds of basis points? You would not do that if you wanted a strong dollar.
And you would certainly not draw up the One Big Beautiful Bill with its unfunded tax cuts. The independent Congressional Budget Office estimated that the budget plan would increase the debt-to-GDP ratio of the US to 124% from 100% by 2034.
In that period, the annual interest costs would double to 4.2%. The annual deficit would be running at 7%.
If you truly cared about the dollar, you would not pass a budget like this, talk about firing the central bank chief, or try to sneak in a wealth tax on global investors.
The Trump administration’s undermining of the dollar is not a bug. It’s a feature. Trump is a Mercantilist — just as the Chinese and the Germans were before them. He wants a manufacturing-based economy.
You would be mistaken to think, as virtually all macroeconomists do, that this attempt is bound to fail. We can debate whether this is a good idea or not. But it will happen. If you create the right incentives, anything can happen. Trump is winning. He is not chickening out. And that’s hard for his opponents to admit.
He needs the tariffs because he needs the money to fund his deficit. It’s as simple as that. There is no higher purpose behind the tariffs. Trump is not concerned about global imbalances. This is the stuff people like me talk about, perhaps too much.
For Trump, it’s just the money.
China has capital controls. It is aeons away from offering similar services. So is the euro.
A world in which the dollar is simultaneously debased and without competition is the most fertile environment for cryptocurrencies. They can thrive through two independent channels: directly, as a store of value and indirectly through stablecoins.
Dollar stablecoins appear to be the only ones with a chance to prevail in online payments systems. You can describe a stablecoins in many ways.
I look at them as financial derivatives whose underlying security are US treasury bonds. If and when the dollar debases, so will stablecoins by definition. As a store of value, they will be as useless as the dollar. I would not touch them as an investment, but they are a potentially important transaction currency.
During a meeting of international finance ministers in 1971, Treasury Secretary John Connally told his colleagues: “The dollar is our currency, but your problem”.
That was 54 years ago. It is still true today.
