How the European Union and Germany Can Leverage Their Monetary Power

The Trump administration’s protectionist “tariff wars” and its “One Big Beautiful Bill” budget proposal, which, if approved, would significantly increase the U.S. deficit and public debt, have once again sparked debate about the potential erosion of the dollar’s status as the undisputed global hegemonic currency.

Investors and central banks appear to be applying a risk premium to U.S. public debt due to the radical economic policies coming out of the White House. In addition, they would like to diversify their reserves away from the dollar. However, for the time being, there does not seem to be a sufficient supply of such securities. This, however, could change. And the key lies in Europe, and more specifically in Berlin. If Germany agreed to issue significant amounts of Eurobonds, the international role of the euro could increase significantly. And with it, the monetary power of the European Union.

Confidence Can Be Lost Quickly

On April 2, 2025, Donald Trump announced “Liberation Day,” imposing base tariffs of 10 percent on virtually every country in the world, and even higher tariffs on the exporting powers, and therefore the most central countries in the global economy: China (54 percent), Vietnam (46 percent), Japan (24 percent), Taiwan (32 percent), and the European Union (20 percent).

Just a week later, after the 10-year U.S. Treasury bond rose from 4.0 percent to 4.5 percent in two days, the administration had to backtrack and announce a 90-day truce to initiate negotiations. Normally, the “bond vigilantes” do not tend to discipline the United States, because it issues the reserve currency par excellence. As a result, the United States enjoys an “exorbitant privilege,” as Valéry Giscard D’Estaing called it back in the 1960s. But protectionist trade policies scare creditors. The bond hike was the first serious warning.

A few weeks later, the U.S. House of Representatives approved a budget bill by just one vote, which, if passed, would increase U.S. spending by more than USD 4.5 trillion over the next decade, pushing the public debt to unprecedented levels. This, of course, also worries investors and holders of dollar-denominated assets. The question is, are there any alternatives to the dollar?

The Importance of Monetary Power

Before delving into this question, it is worth reviewing the concept of international monetary power, developed by Benjamin Cohen, to understand the enormous advantages of issuing a reserve currency. Cohen explains that monetary power allows a country to avoid the costs of balance of payments adjustments and to finance its public deficits at low interest rates. There are two ways to avoid these costs: either by spreading the adjustment over time or, when the adjustment comes, by shifting part of the costs to other countries. The United States has demonstrated enormous monetary power over the past 50 years thanks to the dollar. It has lived beyond its means for a long time. Thus, as Kenneth Rogoff points out in a new book on the dollar, its government, companies, and citizens have financed themselves approximately 1 percent more cheaply thanks to the centrality of the dollar in the international system. The United States has, therefore, delayed adjustments, and when they were eventually made, it shifted some of the pain to others. Furthermore, issuing the dollar has allowed it to exercise a power that is not entirely visible in the international system, which Newman and Farrell call an “underground empire,” through control of international payment systems and the choke points of global finance.

German and U.S. Monetary Power

European countries, and Germany in particular, have been among the main victims of U.S. monetary power over the last few decades. In the 1960s and 1970s, they had to give in to U.S. monetary supremacy, which “forced” Germany to import inflation, much to its chagrin. In the 1980s, the United States also forced the depreciation of the dollar in the 1985 Plaza Accord, which the Trump administration seems to want to replicate with a so-called Mar-a-Lago agreement. This undermined the competitiveness of German exports, and it was then that much of the German elite began to seriously consider the possibility of creating a single European currency. It was the only way to better navigate the dollar shocks coming from Washington, as Randall Henning explained at the time. Therefore, the creation of the euro, which shifted from a vision to reality after the fall of the Berlin Wall in 1989 and the signing of the Maastricht Treaty in 1992, was not only an internal step to deepen the single market and involve Germany more into the process of European political integration, but it was also a defensive tactic by Europe against U.S. monetary power. 

And once the euro was created and reached the hands of citizens in 2002, Germany, which continued to base its growth model on exports, enjoyed a less appreciated (albeit strong) euro thanks to sharing a currency with its southern neighbors. Then came the financial crisis and the ensuing adjustment, which shook the entire eurozone in general—and Germany in particular—because its banks owned many U.S. toxic assets due, in part, to U.S. financial hegemony.

Once again, we saw the United States wielding its monetary power. The Federal Reserve engaged in large-scale quantitative easing, and Germany came under diplomatic pressure from Washington, Paris, Rome, and Madrid for being too orthodox, frugal, and unwilling to bail out the European periphery. In the end, the bailout was delivered through the European Stability Mechanism, and Mario Draghi’s arrival at the European Central Bank (ECB), but slowly, reluctantly, and after a traumatic internal political process within the European Union and Germany. Let us not forget that there were two near-Grexit episodes in 2012 and 2015, and that Alternative for Germany, the far-right party that threatens Germany’s stability today, emerged in 2013 from ultra-conservative economics professors opposed to the euro. However, Angela Merkel understood the historic moment. She positioned herself in favor of Draghi and against the Bundesbank on monetary expansion in Europe and learned her lesson. Furthermore, when the Covid-19 pandemic shook the world, she accepted the creation of Eurobonds to overcome the crisis, even if only temporarily, through the Next Generation EU program. It has been quite a journey for her and her country.

The rise of China as an industrial competitor, Covid-19, the post-pandemic shock to value chains, the Russian invasion of Ukraine, and now the policies of the second Trump administration have exposed Germany’s weaknesses. Its excessive dependence on the Chinese (and U.S.) market, cheap Russian gas, and U.S. military protection now makes it a vulnerable economy in this new phase of transition between neoliberal cooperative rules-based hyper-globalization and the neo-mercantilism and neo-imperial power-based order. Trump is already leveraging U.S. economic influence to its fullest extent, no longer just through monetary power, but also with tariffs, U.S. tech supremacy, and even U.S. military power. But China in particular is not giving in to Trump’s pressure. It remains anchored in the Bretton Woods system, with capital controls, a fixed exchange rate, and a relatively independent monetary policy, and it is unlikely to shift from this posture. This gives China protection to develop its industrial policy, but it also remains the reason why the renminbi is not a serious rival to the dollar, at least not yet.

Toward Joint European Debt Issuance

The German elite is aware of this. Changing the constitution with a two-thirds majority – thanks to votes from the center-right (CDU/CSU) and center-left (SPD) and Greens — to take on more debt (with the word for debt in German being the same as the word for sin) has been a major change. Furthermore, Germany’s new chancellor, Friederich Merz, has stated that Europe must become more independent from the United States. These are strong words in a country that has seen the transatlantic relationship as an anchor of stability and protection. The CDU and SPD government agreement states: “In view of the geopolitical change of era, Europe must develop comprehensive strategic sovereignty. Key technologies, energy security, digital sovereignty, including European platforms, the protection of critical infrastructure, resilience, and the ability to assert itself in global competition are essential for this” (translated by authors). This all sounds well and good in theory, but it must be put into practice and backed by financing.

If the European Union wants to achieve strategic autonomy, it will need to finance a range of European public goods through a larger EU budget. As Bergmann and Steinberg explain, these include defense, energy infrastructure, and the “twin” green and digital transitions. Mario Draghi, in his now-famous report on European competitiveness, estimated that around EUR 800 billion per year, close to 5 percent of the European Union’s GDP, would be needed to achieve European strategic sovereignty. This presents an opportunity to harness the potential of the euro to issue joint debt and project European monetary power.

The level of debt to GDP in the eurozone is significantly lower than in the United States, and the appetite for euro-denominated assets has increased. All of this would allow the European Union to finance its spending needs jointly, and more cheaply and efficiently, than if each country borrowed on its own, especially in a context where some countries have more fiscal space than others.

In a recent study, Blanchard and Ubide explain how to resolve the technical problems of issuing permanent Eurobonds equivalent to 25 percent of the GDP of the eurozone countries—or roughly EUR 5 trillion. In comparison, the current German bond market’s total value is EUR 2.5 trillion, while the U.S. Treasury market reaches USD 30 trillion. The proposed amount of Eurobonds, they argue, would be high enough to generate sufficient euro-denominated assets, which would make European debt markets sufficiently deep, wide, and liquid, thus attracting international investors. Furthermore, they argue that this amount would not be so large as to prevent historically less fiscally responsible countries from exercising control over their public finances (what is known in economics as the moral hazard problem): Debt-to-GDP ratios are estimated to remain at 60 percent for eurozone countries, while a two-tier system of Eurobond and national yields would promote fiscal discipline. The authors also show how the use of value-added tax revenues, combined with other European taxes, could be used to ensure that eurozone borrowing would be paid back. Moreover, as future issuances of Eurobonds would be expected, the market would cease to regard them as temporary. This would make the 10-year Eurobond a serious competitor to the 10-year U.S. Treasury bond, which is the anchor asset of the international monetary system. It would dramatically soften the fiscal constraints on European countries. Christine Lagarde, the ECB president, has recently endorsed this view. In the past, the ECB, one of the most cautious and conservative EU institutions, never explicitly supported promoting the international role of the euro. This is another radical change.

Issuing large quantities of European sovereign debt would not, of course, end the hegemony of the dollar. However, it would open the door to a multicurrency world that would better correspond to the current economic multipolarity of the international system. It would also empower a giant step forward in European integration, which is necessary if the European Union wants to be a relevant pole in the increasingly tense world of great power competition.

Federico Steinberg is a visiting fellow with the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies in Washington, D.C. Miguel Otero-Iglesias is senior fellow at Elcano Royal Institute and professor and research director of international political economy at the School of Global and Public Affairs and the Centre for the Governance of Change at IE University in Spain.