Lagarde says euro could challenge dollar as global reserve currency

Christine Lagarde used a speech in Berlin on Monday to argue that the euro has a genuine chance to displace the US dollar as the world's primary reserve currency, but she was blunt about the political and structural obstacles that have kept the single currency stuck at roughly 20 percent of global reserves for two decades.

The dollar's decline and the opening for the euro

The US dollar still dominates international reserves at 58 percent, according to the latest IMF data, but that is the lowest share since the mid-1990s. The euro has hovered around 20 percent since the financial crisis, unable to convert the euro area's economic weight into monetary influence. Lagarde told her Berlin audience that the "erratic economic policy of the United States" has spooked global investors, who have reduced dollar exposure and bought gold instead, because they see no credible alternative. That vacuum, she argued, is the euro's opportunity.

The ECB president's language was notably geopolitical. She said investors now seek "geopolitical assurance in another form: they invest in the assets of regions that are reliable security partners and can honour alliances with hard power." The implication was clear: a currency's reserve status rests not only on economic depth but on the issuer's ability to project security. Europe's fragmentation on defence, she suggested, undermines the euro's claim to be a true alternative.

Capital markets union remains the missing piece

Lagarde identified the euro area's fragmented capital markets as the central economic obstacle. The bloc lacks a deep, liquid pool of safe assets that global investors can park money in at scale. US Treasury bills play that role for the dollar; the euro area has no equivalent. She repeated the case for joint borrowing, common issuance backed by all member states, as the mechanism to create such an asset. "Economic logic tells us that public goods need to be jointly financed. And this joint financing could provide the basis for Europe to gradually increase its supply of safe assets," she said.

The argument is not new. The capital markets union project has been on the European Commission's agenda since 2015, with limited progress. National supervisors, differing insolvency laws, and the absence of a European deposit insurance scheme have kept markets balkanised. Lagarde's intervention adds the weight of the central bank to a debate that has largely stalled in the Council.

Germany's veto on joint borrowing

The political resistance is concentrated in Berlin. Germany has long treated joint borrowing as a red line, fearing that its taxpayers would ultimately cover the debts of less disciplined members. The pandemic-era NextGenerationEU programme broke that taboo temporarily, but it was explicitly designed as a one-off. Lagarde acknowledged the sensitivity: "Joint borrowing has been taboo for some key eurozone members, particularly Germany, which fears that its taxpayers could end up having to pay for the fiscal irresponsibility of others."

That fear is not abstract. The euro area's fiscal rules, reformed only last year, still allow debt-to-GDP ratios above 60 percent in several large economies. Italy's debt stands above 130 percent of GDP; France's is near 110 percent. Without a credible mechanism to enforce discipline, German policymakers argue that mutualised debt creates moral hazard. The stalemate has persisted through multiple commissions and crises.

Trade invoicing as a lever

Lagarde also pointed to a more immediate lever: invoicing. The euro is used in roughly 35 percent of extra-euro-area goods exports, but the dollar dominates in energy, commodities and many services. She argued that new trade agreements, enhanced cross-border payment infrastructure, and liquidity lines with the ECB could shift invoicing toward the euro. That would create natural demand for the currency without waiting for capital markets union to finish.

The ECB has already expanded its swap line network, including agreements with major emerging-market central banks. But the dollar's incumbency is self-reinforcing: deep markets attract liquidity, which deepens markets. Breaking that loop requires coordinated policy, trade, finance and monetary, that the EU struggles to deliver because competence is split between the Commission, the ECB and national governments.

The security-currency nexus

Lagarde's insistence that currency credibility requires "hard power" marks a shift in ECB communication. The bank has traditionally avoided security policy, treating it as outside its mandate. But the president's argument reflects a growing view in Frankfurt that the euro's international role cannot be separated from the EU's geopolitical weight. The dollar benefits from the US security umbrella; the euro has no equivalent.

This connects to the debate on European strategic autonomy. The EU's defence initiatives, the European Defence Fund, PESCO, the recent push for a defence commissioner, are still nascent. Defence spending across the bloc averaged 1.9 percent of GDP in 2023, below the NATO 2 percent target for most members. Without a credible security architecture, Lagarde implied, the euro will remain a regional currency with global ambitions.

Reform at home before ambition abroad

Lagarde conceded that domestic reform may be more pressing than global ambition. The euro area's banking union remains incomplete: a common deposit insurance scheme has been blocked for years, and the single resolution fund is not yet fully mutualised. Supervisory practices still vary. The ECB's own stress tests show that cross-border banking integration has barely advanced since 2015.

On the fiscal side, the new economic governance framework allows more gradual adjustment but does not create a central fiscal capacity. The EU budget remains roughly 1 percent of GNI, tiny compared with federal budgets in the US or China. Without a meaningful central budget, the euro area lacks the automatic stabilisers that support reserve currencies during crises.

What would change if Europe acted

Lagarde outlined the payoff: lower borrowing costs for European firms and governments, insulation from dollar-driven exchange-rate volatility, and protection against extraterritorial US sanctions. The last point has gained salience since the US used the dollar's clearing role to enforce sanctions on Iran, Russia and others, forcing European companies to choose between US market access and EU legal obligations. A more international euro would give the EU leverage it currently lacks.

But the sequence matters. Deeper markets need joint assets; joint assets need political trust; trust needs enforceable rules. The EU has spent a decade circling this triangle. Lagarde's speech adds urgency but does not resolve the underlying distributional conflict: who pays, who decides, and who bears the risk.