Donald Trump is giving the euro a chance to dethrone the dollar

Since Franklin D Roosevelt dethroned sterling as the world’s reserve currency 80 years ago, the dollar has reigned supreme as the global currency of choice.

Known as the “exorbitant privilege”, its reserve currency status has allowed the US Government to borrow on a vast scale without a flicker from markets, attract cash in global crises while other nations struggle to access finance, and even lay down the law to America’s enemies, by compelling banks to enforce sanctions.

That reserve status, and the power which comes with it, has been unshaken for decades.

But two factors have recently put the dollar’s safe haven status at risk.

First, doubts about Donald Trump’s scorched-earth approach to America’s allies risk undermining the dollar.

Second, hopes for Europe’s response to the crisis raise the possibility of an alternative to the greenback at last emerging in financial markets.

If America’s government and its commercial links look unreliable, investors and traders will cast around for alternatives to the dollar. And if the eurozone nations at last take the plunge and issue joint debt on a large scale to fund rearmament and economic restructuring, a giant new market could ultimately emerge to challenge the dollar’s position.

The dollar’s power is grounded in its usefulness as a means of exchange. As the biggest and most liquid currency, most trade even between two countries which use other currencies is typically routed via USD.

The Federal Reserve estimates that between 1999 and 2019, the dollar accounted for 96pc of international trade transactions in the Americas, 74pc in Asia and 79pc around the rest of the globe. Only in Europe is it used for a minority of transactions, with the euro the most commonly invoiced currency.

In the foreign exchange market, the US dollar is on one side of around 90pc of all transactions.

As Trump tears up trade deals – even those he signed himself, as with his threats to Canada and Mexico – and uses tariffs as a tool of intimidation against those he feels have wronged him or his nation, or just to seize momentary advantage in talks on unrelated topics, so the dollar becomes less attractive.

Higher tariffs mean less trade, less use of the dollar, slower economic growth and fewer opportunities for global investors to make money in America. All of that adds up to a weaker status for the currency.

Kamakshya Trivedi, of Goldman Sachs, warns that persistent policy uncertainty could dismantle the dollar’s hegemony.

“The dollar’s strength over the last decade is not the product of official demand, since reserve managers have been trimming their dollar holdings through much of that period. Dollar strength instead has been a function of private capital chasing superior return prospects,” he says.

“By the same token, some of the dollar weakness in recent weeks has also coincided with better returns across equities in Europe and China, and nascent investor pessimism around US growth prospects.

“And that’s the channel to focus on: if we see the environment of policy uncertainty since January continue to weigh on US growth and capital return prospects, that is more likely to erode dollar dominance than any accord or agreement.”

The president’s plans for defence could have a similar effect, nominally saving Washington money in the short term but ultimately costing it support from investors in the years to come.

Constantin Bolz, of UBS Global Wealth Management, says Trump’s lurch to isolationism could drive investors away from US treasuries, exacerbating the debt burden.

“The US has been the ‘defender of the world’, by supplying defence in many parts of the world. For that the US defence budget was bigger than that of most others, and in exchange, many other countries held a lot of US treasuries in their reserves,” he says.

“If the US now wants to reduce its defence expenditure for others, others will reduce their holdings of US treasuries, as they will have to fund the defence themselves and will need to issue debt for it.”

This risks very real costs for America, not only in terms of its ability to use the dollar to throw its weight around globally, but also in terms of financing Trump’s own spending and borrowing plans.

Under Trump’s first presidency and that of Joe Biden, the US Treasury racked up monumental debts.

Markets kept funding its borrowing, even as the debt surged from $18 trillion a decade ago to more than $35 trillion now, with Washington running big deficits in good years and bad.

Economists and financiers have long worried that even the US would run out of room to borrow one day, but few tend to think that day is anywhere close. Anything which brings it closer – like Trump’s actions – could imperil the finances on which the Government’s plans, and swathes of the economy, are based.

America’s enemies have longed for that day. After the US rolled out fully-fledged sanctions against Russia in 2022, the Brics (Brazil, Russia, India, China, South Africa, Egypt, Ethiopia, Indonesia, Iran and the United Arab Emirates) nations in particular began to view dependence on the dollar as a liability.

Vladimir Putin told the Brics Summit in 2024 that “the dollar is being used as a weapon”, before noting that nearly 95pc of trade between Russia and China now takes place in local currencies, escaping America’s reach.

Yet even at that summit in Kazan, in Russia, attendees were advised to bring cash – and specifically dollars – as card payments providers cut the country off in the wake of the invasion of Ukraine, and local banks are desperate for hard currency.

Dmitry Dolgin, chief economist covering Russia for ING Bank, says the Brics nations have little scope to fully replace the dollar in their reserves.

“The amount of liquidity that would be needed to replace the dollar would be huge. There is not enough gold in the world, so this process of de-dollarisation is limited by lack of alternatives,” he says.

That is where Europe steps in – not necessarily as an appealing option for the Brics bloc, but as an alternative to the dollar for everyone else.

When newly introduced at the turn of the millennium, the euro was considered a potential challenger to the dollar, even as a boom in commodity prices following China’s accession to the World Trade Organisation weakened the greenback.

Yet the 2008 financial crisis and eurozone debt crisis diminished the euro’s standing, tipping the balance back in the dollar’s favour, seemingly cementing its dominance.

Now the tables might turn once more. European nations are stirring from their slumber.

Led by Germany, governments are announcing major plans to seize control once more of their own destiny, hoping to lay the groundwork for rearmament and a new strategic independence from the suddenly untrustworthy US.

Ursula von der Leyen, the European Commission’s president, has proposed an €800bn bonanza. Berlin, under Friedrich Merz, its likely incoming chancellor, could spend €500bn on infrastructure and borrow heavily to reestablish a meaningful military presence.

Isabelle Mateos Y Lago, of BNP Paribas, says the dollar had been upheld as the unquestioned dominant reserve asset because of a lack of suitable alternatives, the resilience of the US economy and geopolitical role of the US.

“In recent weeks these pillars have found themselves challenged in deeper ways than ever before,” she says. “It is notable that the dollar has been losing value despite the imposition of large tariffs, suggesting that something else is at play that could reflect in part a loss of confidence in its safe-haven properties.”

Safety is relative. The euro might just be a challenger to the dollar’s place on the throne.

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