An article on the fundamental flaws with the euro triggered this post.
What Are the Key Reserve Currency Requirements?
- Deep, liquid, open bond markets
- Floating currency
- Property rights
- Ability and willingness to run trade deficits
The euro flunks requirement one due to lack of a Eurobond. Germany flunks rule four.
What Are Eurobonds?
Eurobonds don’t exist. But the idea is a centralized debt similar to US treasuries.
Instead, the European Monetary Union (EMU) has German bonds, Italian bonds, French Bonds, etc.
By the Maastricht Treaty that formed the EMU and created the euro, there would be no commingling of debts.
The no comingling demand was by the insistence of Germany and the Northern European states.
Eurobond Cheerleading
One of the biggest Eurobond cheerleaders for two decades was Wolfgang Münchau, founder of Eurointelligence.
Münchau surprised me with a statement that he no longer supports Eurobonds.
Please consider A Lost Hamiltonian Moment by Wolfgang Münchau.
I used to support eurobonds, but no longer do because the only ones on offer are of the toxic variety.
I can’t remember how many columns I have written calling for a eurobond. I no longer do. The problem with the eurobond is not the large number of people who oppose it. The problem were its friends.
Maybe it was naivety on my part. I stuck to this very German view that a eurobond would the financial debt instrument of a political and fiscal union; that it would be the natural counterpart to the euro. My naivety consisted in the belief that everybody else would see that too, except for those who are opposed to further European political integration.
It took me some time to realise that the majority of people who also supported the idea were not interested in a genuine political union with tax raising and debt-issuing powers. They were not even interested in the bond. They were just interested in the money.
Economists have come up with many eurobond schemes that have in common that they all tried to avoid the complication of a treaty change. There was a debt redemption bond. There was the blue-red-bond idea, where a portion of national debt was declared European, and another as national. Today, there are only two types of schemes that are still alive in the discussions: the recovery fund mechanism and the synthetic eurobond, created out of existing bonds.
The recovery fund is the version that happened, tragically so, because it will forever undermine political support for a eurobond in northern Europe. Its proponents celebrated it as the EU’s Hamiltonian moment. I thought this was an insult to Alexander Hamilton, the US’s first treasury secretary who was instrumental of turning state debt raised during the Revolutionary Wars into federal debt. His federal bond was that of a political union. The recovery fund, by contrast, was a debt transfer scheme that channelled money from some governments to others – with the ECB oiling the wheels through its pandemic emergency purchase programme, and the European Commission in the role of the referee. The recovery fund failed to raise productivity growth, its declared purpose, including in Italy and Spain, the countries that were the main recipients.
Bond markets did not regard it as a sovereign debt instrument either. As the EU lacks a fiscal union, it has no independent tax raising and debt issuing powers. The recovery fund bonds exist through the kindness of EU members, which can leave the EU at any time, and without any legal responsibility for the EU’s future debt. The recovery fund falls into the category of structured finance product that gets around the legal problem that the EU lacks sovereign powers.
The other instrument people are still talking about is the synthetic eurobond. It involves no debt mutualisation at all. Think of it as a new bond, made of a basket of existing bonds. The closest comparisons are the collateral debt obligations that brought down the global financial markets in 2008. Like those CDOs, a synthetic eurobond might attract a triple-A rating. But if one member stated defaulted on their national debt, that entire construction would collapse, because legally no one would be under any obligation to pay more than their own share.
I always thought of the synthetic bond as a smoke-and-mirror construction – a way that allows you to claim that you are solving the problem when you are not. The synthetic eurobond was another moment of my dawning realisation of the futility of the whole idea.
Nobody ever needs complex financial debt instruments. But they can be very useful for those who issue them if the goal is to hide risk, or get around some inconvenient laws. That is what happened during the global financial crisis. And that would have been the purpose of synthetic eurobond as well.
The eurobond I had mind was the boring variety, the vanilla version, as they say in the bond markets. It would have required treaty change to create a political and fiscal union. The order of magnitude I had in my mind was a fiscal union that would account for some 5-7% og GDP: not a full-blown state, but an entity with some discretionary spending power. [A partial union]
Today, the eurobond is reduced to the notion that the EU needs money for investment. Germany is the only large country with enough fiscal space. It is right therefore, so the argument goes, that it should share that fiscal space with others. But this means that poor people in a rich country end up subsidising rich people in a poor country. This type of eurobond constitutes a regressive tax, not based on a person’s ability to pay, but on where they live. I am not in the least surprised to see a popular backlash against the idea of European integration in Germany and other northern European countries, which would have been equally affected.
Fiscal conservatives have warned me that this is what would happen – that the eurobond would end up as a debt mutualisation and monetisation scheme. They were right. They claimed they too favoured a genuine political union with a eurobond. I never believed that part of their story.
The truth is that the eurobond died because nobody ended up fighting for it. Its supporters had other agendas. Synthetic is as good as it will get. And I am totally disinterested in it.
Recognized Flaw
Lack of a Eurobond was a recognized flaw in the Maastricht Treaty from the outset. However, the euro founders though the EU would grow closer over time and Germany would finally OK the idea.
I thought otherwise.
The ECB says all EMU government bonds are the same, and it guarantees them. In practice, we know they are not equal because they have different yields.
To get around debt comingling, the ECB concocted a Target2 scheme that guarantees the government debt of the individual countries.
What Is Target2?
Target2 stands for Trans-European Automated Real-time Gross Settlement System. It is a reflection of capital flight from the “Club-Med” countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.
For example: “Spain imports German goods, but no Spanish goods or capital have been acquired by any private party in Germany in return. The only thing that has been ‘acquired’ is an IOU issued by the Spanish commercial bank to the Bank of Spain in return for funding the payment.”
This is not the same as an auto loan from a dealer or a bank. In the case of Target2, central banks are guaranteeing the IOU.
Target2 also encompasses people yanking deposits from a bank in their country and parking them in a bank in another country. Greece provided a nice example, and the result was capital controls by the ECB during the 2008 Greek crisis.
Target2 Balances
The Target2 Chart is from the ECB.
The Target2 situation has gotten better since 2022 led by Italy, but France has taken a huge turn for the worse.
The threat of tiny Greece defaulting nearly blew up the system in 2008.
If Italy or Greece (any country) were to leave the Eurozone and default on the target2 balance, the rest of the countries would have to make up the default according to their percentage weight in the Eurozone.
Eurointelligence accurately noted “If one member stated defaulted on their national debt, that entire construction would collapse.“
The Target2 construct is only as good as the weakest country in the EMU.
Reserve Currencies
The US dollar is the world’s reserve currency.
Over the years, there has been much discussion of using the euro or the yuan, or even sillier, a BRICS-based currency as the reserve currency.
I have been discussing the silliness of these ideas since 2011 at the latest.
Please consider this May 31, 2011 flashback: Reflections on the Yuan as a Global Reserve Currency; Hype Sells
An interesting article in the Financial Times got me thinking once again about the popular notion that the Yuan is about to replace the dollar as the global reserve currency.
Reserve Currency Requirements
- Deep, liquid, open bond markets
- Floating currency
- Property rights, civil rights
- Political stability
- Political freedom
China flunks on at least 4 of 5 points, and arguably all 5. It may be a decade before China even floats the Yuan. How long before China has a deep, liquid, bond market?
Yet, somehow hyperinflationists persist in spreading nonsense that the Yuan is somehow on the verge of replacing the dollar as a global reserve currency and that may cause hyperinflation.
There certainly may be more local trading in the Yuan. In fact, it is likely. That does not imply the death of the dollar or the loss of reserve currency status and it certainly does not portend hyperinflation.
Why is the “hyperinflation is imminent” scare everywhere you look? The answer is simple: Hype Sells.
The bigger the hype, the sexier the story, and the more people are attracted by it.
Implicit Requirement to Be a Global Reserve Currency
I did not mention it in the 2011 article but I have mentioned this important thought many times: To become a global reserve currency a county must be willing to run deficits. That is my new requirement number 4.
Countries accumulate US dollar reserves because the US runs trade deficits with most of the rest of the world.
Factor in the world’s largest, most liquid bond market and strong property rights. That’s all you need to know about why the US dollar is the global reserve currency.
I dropped points 4 and 5 from 2011 not because they are unimportant, but rather they are hard to define.
China is not willing to run trade deficits, still does not float the yuan, still has no global bond market, and has no property rights to speak of, and yet there is still nonsensical talk of the yuan or some mythical BRICS-based currency sponsored by China becoming a global reserve currency.
A Gold-Backed BRICS Currency
To keep the hype going, there is periodic discussion of a gold-backed alternative to the dollar.
For example, please see my July 7, 2023 post More Gold Backed BRIC Currency Silliness on Dethroning the Dollar
If Russia or China had a gold-backed BRIC, what would that even mean? Would you trust it? Buy it?
Kitco reports Russia Confirms BRICS Will Create a Gold-Backed Currency
My first thought was the announcement was bullsheet. My second thought was the same.
Marc Chandler, managing director of Bannockburn Global Forex, provides my third thought: “Talk of BRICS gold backed currency seems like an echo chamber. They do not have the gold to back a currency meaningfully. Have we not learned anything from the EMU experience of monetary union without fiscal union. Color me profoundly skeptical.“
This echo chamber has been reverberating for years.
Thorsten Polleit, chief economist at Degussa hits the nail squarely: “For making the new currency as good as gold, a truly sound currency, it must be convertible into gold on demand. I am not sure whether this is what Brazil, Russia, India, China and South Africa have in mind.“
Trade is Between Individuals, Not Nations
Please note that Countries Don’t Trade.
- Only individuals, separately and in voluntarily formed groups such as firms, create or take advantage of economies of scale, of scope, or of both in production; countries, as such, do not.
- Only individuals, separately or in voluntarily formed groups such as firms, spend, save, and invest; countries, as such, don’t.
- Only individuals experience income, wealth, or welfare gains and losses; countries as such experience nothing.
Trade Example
- A Brazilian soybean producer sells soybeans to a merchant in China.
- A Brazilian scooter manufacturer buys Lithium batteries from a Chinese merchant.
- The soybean producer buys nothing from Chinese merchants.
- The Chinese battery producer buys nothing from Brazilian merchants.
Why would the Brazilian soybean producer want to hold yuan, especially given that the yuan doesn’t even float?
Why would the Chinese battery producer want to hold the Brazilian Real?
The yuan and ruble are not easily converted to anything. The same applies to the mythical BRICS.
According to state-run RT, the Russian government has confirmed that Brazil, Russia, India, China and South Africa, also known as BRICS nations, will introduce a new trading currency backed by gold.
Backed gold is never explained.
No one is forcing the soybean producer or the battery producer to do anything. By choice they prefer to trade in dollars, which by the way is instantly convertible to any currency the producers may wish to hedge in.
An alleged trading currency does nothing to change the preceding paragraph.
People get the foolish notion that trade is between countries because economists total up all the individual transactions and report trade deficits and surpluses by country.
The Reserve Currency Curse
It’s understandable that nations, especially Russia, want to avoid dollars. There is mistrust for many good reasons.
But until there is a suitable replacement, the US is stuck with the curse of being the global reserve currency.
It’s a curse because it implies willingness to run trade deficits. China and Germany refuse to rebalance even to neutral.
Trump Threatens BRICS
On January 31, 2025 Trump threatened BRICS with tariffs if they replace US dollar
“We are going to require a commitment from these seemingly hostile countries that they will neither create a new BRICS currency, nor back any other currency to replace the mighty US dollar or, they will face 100% Tariffs,” he said on his Truth social media platform.
“There is no chance that BRICS will replace the US dollar in international trade, or anywhere else, and any country that tries should say hello to tariffs, and goodbye to America!” he added.
Those comments show how clueless Trump is on trade and reserve currencies.
Trump, not BRICS, Is the Threat to the Dollar
As explained above, BRICS are no threat to the dollar. Rather, Trump is the threat to the dollar.
Tariffs will reduce trade. That will slow the holding of foreign dollar reserves.
Trump’s moves on Canada will strengthen Canada’s ties with the EU and less with the US.
Trump’s tariffs on China have already driven China and Russia closer.
A recession will mean less US imports and thus reduced accumulation of US dollars overseas.
Trump demands nations keep using dollars at the same time he degrades their means and desire to use dollars!
Q: How Long Can the Dollar Remain the Global Reserve Currency?
A: At least until there is a suitable replacement.
There is no replacement in sight. However, the US dollar role in global transactions on a percentage basis is declining.
Trump tariffs, sanctions, and general untrustworthiness (who can believe Trump will honor any deal he makes) will escalate the trend away from dollars.
So will increasing US budget deficits.
Nonetheless, death of the dollar ideas are very overstated because no replacement is in sight.
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Until TRUST in the US government is broken and that is coming faster than we think …
“Full Faith and Credit”
That is the reason the dollar has value. All Fiat currencies are based on faith – belief.
Nothing more?
In the case of the U.S. Dollar as a reserve Currency it gives our nation incredible strength and leadership. Our military strength, our banking system, technological leadership, educational system, our incredible social infrastructure ~ like the interstate system and our remarkable airports, ports and defense systems.
Trump certainly erodes respect for & confidence in our nation, but he is a good patsy for the Neo-Cons that if nothing else through their military bravado, provide social stability and almost unlimited access to the worlds resources in exchange for dollars.
Our Dollar has given us a technological “Gilded Age”.
Savor this time…
Good analysis, Mish. Sooner than the 2033 predicted, they’ll have to print $s to pay SS/Medicare. It is easy to imagine that changing international attitudes. Perhaps loss of reserve status without anything replacing it?
“Trump tariffs, sanctions, and general untrustworthiness (who can believe Trump will honor any deal he makes) will escalate the trend away from dollars.”
If only there was some indication before his elevation this would be the case.
What choice did we have? Lying is the default action of all Dems.
At least he kept his promise to seal the border and to appoint RFK & other MAHA.
Did you not see the ballot? The Libertarian party was/is a choice and they are for a balanced budget. The uniparty republicans and democrats want people to think theyre the only 2 choices, that way people vote for more deficit spending, debt, and debasement no matter which of those 2 they pick.
“If only there was some indication before his elevation this would be the case”
Where on earth were you for his last term and his insurrection when he lost?
😉
Countries hold many different assets are part of their reserves, including physical gold. I just think we’re going to continue running budget deficits and creating money so there’s a possibility of people dumping the dollar.
The greenback will stay the world’s reserve currency as long as investors have faith in the creditworthiness of the US Treasury / Fed. IMHO, we’re into a higher for longer super cycle, which means that treasuries will continue to pay higher yield than the Euro and most other currencies with high credit ratings. Yield solves demand issues.
When our debt crisis arrives remains very hard to call. I don’t see Congress engaging in any meaningful austerity in terms of cutting spending or raising revenues through taxes, so maybe we won’t have to wait too much longer.
I think the next recession will lurch us towards major problems in the treasuries market. Congress & the Fed will throw helicopter money again like they did in 2020, exacerbating the debt to GDP problem. As I’ve said though, spending $2T+ extra every year goes a long way towards keeping the economy juiced & out of a recession.
The constitution says that the debt should not be repealed. Why in case of default courts wouldn’t enforce what required to repay ?
Swiss franc?
Rolling on the floor laughing.
All that is required is an inflection point. At an inflection point, Nixon closed the gold window. That which cannot go on forever, creates an inflection point. I believe it was James Dines, who told Greenspan that gold was going to go up to $X and Greenspan said that the government would never allow that. Greenspan was wrong.
Today, China is allegedly buying up gold as if there is no tomorrow. Read gold is becoming a Tier 1 asset again. Something is up. All the Great Reset talk isn’t just idle chatter.
Brent is down because with Iran neutralized everyone in the region and Europe feels a big surge of relief. Although the problem is not over there is now a way to make it over.
Sorry to be off topic.
Mish, how does Israel continue to run trade deficits almost every year since 1959?
https://www.fxempire.com/macro/israel/balance-of-trade
They can do this because Jews worldwide are sending money back to Israel every year.
And they give it back in investments that actually are worthwhile.
like 9.11.01 ? one of bin laden’s reasons was our propping up israel and saudi.
and the amerikan treasury supports israel with currency and the trillion dollar per year department of war and VA. i some us taxpayers are jews and muslims and christians and hindus and non believers……….
The U.S. government loans Israel billions every year and then forgives the loans.
With that cash they buy some of our munitions and a whole lot of digital technology corporations. They bought C-Cube Microsystems about a decade ago. C-Cube technology is the basis for cellular telephone and this allows voiceprints to be made and the use of them for security and military applications.
You really would not want to be a criminal in todays world!
Sometimes technology has benefits and I expect that Trump will start deporting American criminals after he gets rid of the immigrants.
Like I said, it would suck to be a bad guy!
>
Agree with assessment. The fundamental issue is TINA (There Is No Alternative). For all the people that keep saying the dollar is going to collapse please tell us what you’re trading your USD for right now that isn’t gold?
Long ago, I had a co-worker that went out of his way to buy Chinese Yuan because it was the currency of the future. I snickered and he said, “you’ll see!” That was 20+ years ago. Lost track of him but I doubt he came out ahead on that trade.
But the prudent and pragmatic thing to do is to diversify into a variety of financial assets and currencies. These days it’s easy to buy ETFs that invest in practically any part of the world so it’s easy to do.
If anything ever does replace the USD it may be a digital currency which is why I own a small amount of bitcoin but that may take decades if ever.
You may own more bitcoin then you think you do, it you own S&P 500 you own a piece of (coin), and if you own QQQ you own a piece of (mstr)
the usd is already digital. vast majority of usd is just a computer cursor stroke of zeroes in your bank or brokerage account. no need for the treasury to chop down trees and confiscate printing presses like decades and centuries past. hit zero and presto.
The dollar is already dead. The Dollar now goes down on global turmoil, that’s all you need to know. Next up, rates goes up on global turmoil too. Just like a 3rd world currency.
2. Is floating currency requirement? No need to be floating.USD was fixed to gold before 1972 and was reserve as well. Floating because of deficit and if not all the gold won’t be left.
3 property right if you’re not labelled as adversary..
4. Ability and willing to run trade deficit. After 50 years there is limitation of debt and deficit. Link to gold was severed to be hegemonic.
So you don’t need to float your currency to be reserve. Also doesn’t need to run trade deficit as USD before 1972.
I believe Mish was using “floating currency” to mean “floating FIAT currency” as there is no currency I am aware of that is NOT fiat – the implication is obvious to the most casual of observers.
Yes. Pre-1972 was just after the pseudo-gold standard was ditched. But we were running deficits in gold which is why Nixon closed the gold window.
So what?
How is this relevant?
After 1971, the dollar was a pure fist currency. I was agreeing with you but also pointing out that the pseudo-gold standard was unsustainable. Duh!
wrong. gold is the real reserve money. pre 2001, you could tour the basement of the nyfed reserve and see for yourself.
Mish, there was not a single reference to Brent Johnson and his Dollar Milkshake Theory. You and he should write together and create a powerful force for reasoning.
US$ will be reserve currency for many many more years to come like Pound and coexist with other reserve such as Yuan, Euro,Yen, Pound, etc. Only percentage will change. Obviously USD will drop from very high percentage and Yuan will gain substantially.
Germany and Italy pressed to bring $245B of gold home from US
https://archive.is/6CDR5
I’m going with Luke Gromen’s take on the issue. The dollar will remain the major transactional currency (i.e. unit of account) but US Treasuries will not be where other countries hold their reserves (i.e. store of value).
Luke’s proposal is mathematically impossible/
I have explained why many times.
Please link that. I have read some of your responses but I don’t recall them arguing against less Treasury holdings. Foreign holdings of Treasuries have not been increasing while debt has been.
Mike dumb question but included in 1 & 2 are capital controls correct?
Great article.
I meant to add Michael Pettis was my go to guy on this topic, no offense LOL. It is a very imformative article
Well put Mish
CNY is a turd. Falling demographics, mercantilist over production, under consumption, military hopes fading. EUR surely you jest. Same except for under production now.
USD is a turd. Falling demographics, mercantilist over production, under consumption, military hopes fading.
For the foreseeable future.
5) Willing and able to replace your goods industry by a financial industry.
6) Willing and politically capable of supporting a growing amount of wealth concentrating into a corresponding smaller percentage of the population as time goes by.
7) Willing to cede control of both monetary and fiscal policy to surplus nations.
Is there any country not willing to do #6? Maybe the old USSR but certainly there is no country today that wouldn’t do #6.
You are right but it is a powerful part of the feedback loop. As wealth concentrations increase, economic theories that justify this concentration proliferate in the media for example.
Our lowest 10% earning class is the envy of the third world!
Our middle class is wealthy by any standard…
Have you toured America lately? It is a fabulous country!
You always judge how well you are doing by how well-off you are compared to your peers. It’s is human nature. No one in the US will compare themselves to a Bushman in the Kalahari and say I am rich and should be happy. It’s apples and oranges. If you think that the bottom 50% holding only 2.8% of the country’s wealth is not a potential problem then I would love to know why you think so. Please tell me.
By the way I am American and I spend every year usually three or more months in the US so I am well aware of conditions there.
The bottom 90% of America’s population owns about a third of the wealth, another third is owned by the next 9%, and the other third is owned by the top 1%.
On the other hand, the bottom 50% still own about $4 trillion, or about $23,000 each….
Still waiting for your argument. Cat got your tongue?
Why would a Brazilian want to hold yuan? Because in Brazil he can only hold BRL. All the Brazilian foreign trade exchanges are conducted by the central bank and the Brazilian party get the only currency it can hold in domestic banks: BRL.
A reserve currency may be convenient, but it’s not necessary.
The US continually runs a deficit – someone somewhere must hold dollar assets
Can you open an account in the US in whatever currency you like?
In the case of Brazil, its central bank would. However, the Brazilian soy exporter has no say whether the central bank will hold USD, BRL or RMB. It’s the central bank’s choice. But he has no such choice.
Again, a reserve currency is a convenience, not a necessity. The previous reserve currencies, like the British pound or the Dutch guilder, didn’t meet your criteria either, but they met mine: convenience.
I find #3 and 5 to be rather naive. The US/EU can steal and confiscate as they wish. If sanctions haven’t made this obvious, then banning political opposition in Europe should. Anyone can win, if there’s no second entrant.