Talking With Hélène Rey

The international role of the dollar and more

My old teacher Charlie Kindleberger used to tell his students that anyone who spends too much time thinking about international money goes mad. It’s a subtle topic, one in which it’s all too easy to mistake mysticism for wisdom.

Fortunately that hasn’t happened (yet?) to Hélène Rey of the London Business School, one of my go-to economists on the international role of the dollar, exorbitant privilege, financial cycles and more. We talked Thursday about these subjects, with some inevitable discussion of current events. Transcript follows.

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TRANSCRIPT:
Paul Krugman in Conversation with Hélène Rey

(recorded 8/7/25)

Paul Krugman: Hi everyone, Paul Krugman again. I am speaking this week with Hélène Rey who is one of the world's leading experts on international macro and money, and especially on international roles of currencies. So we want to talk a lot about that. But first, hi, Hélène.

Hélène Rey: Hi Paul, delighted to be on again and to talk to you.

Krugman: Yeah. So there's been a bit of news this past week. As you know, the Trump tariffs have come into full force supposedly. Before we get into sort of the more analytical economic stuff, sitting on your side of the Atlantic, what do things look like to you?

Rey: Well, these new tariff deals, or so-called deals between the US and Europe, I think a lot of it is seen to be probably not enforceable anyway, because all these investments that have been promised are supposedly done by the private sector. There's no way that it can be properly enforced. Obviously. However, what is important for us in Europe, I think, is that the optics have not been great in the sense that the European Commission is seen as having been a bit subservient to Trump. And I think that's not good for the sovereignty of Europe. Plus, obviously, with Trump, you never know when it stops, right? Because things are being constantly revisited. We don't know. There's still a lot of uncertainty about what may or may not happen with these deals. But overwhelmingly in Europe, one of our main concerns is Ukraine. And that weighs on everything.

Krugman: Okay, yeah. I don't know if you saw, but Trump was on TV the other day saying that he thinks that he's getting a $600 billion fund from Europe that he can spend however he likes, which is not at all what Europe thinks it agreed to and actually is probably impossible to do anyway. So it's pretty amazing.

Rey: Absolutely. That's what I was saying. I don't know what deal he thinks he has got, but it doesn't look like that at all [from Europe].

Krugman: Yeah. So, we do want to talk about currencies a lot but before we get directly onto that, one of the things that I think about how credibility is not fully divisible, that if you're not viewed as someone who keeps your word on one thing, then you're not going to be trusted. And this craziness on tariffs and all, how do you see that? One of the odd things has been the behavior of the dollar, just the exchange rate. You know, tariffs should strengthen the dollar. It's actually gotten substantially weaker. What do you think is going on?

Rey: Well, I do think that first of all, Trump has ushered into macroeconomic policy an incredible amount of uncertainty. And second, in terms of credibility, I mean, you know the nickname, TACO, that he has been getting. [Trump Always Chickens Out] And also, I think the constant attacks on institutions of the United States, which are undermining the credibility of the currency, are actually very serious. So tariffs are one thing, okay, and that's a non-trivial issue. There's a lot of uncertainty, et cetera. But the constant attack of this administration on the traditional institutions underpinning U.S. long-term growth and U.S. strength in innovation, in technology, such as the attack on universities, but also on the financial side—the attack on the Federal Reserve. All this, I think, is extremely serious and I think is really leading to a reassessment in the rest of the world of the dollar as a currency that one can fully trust.

Now, I also think that the world was very much overweight in terms of dollar assets until the famous April 2nd Liberation Day episode. So we had the rest of the world having loaded up massively on US equities for many, many years. And that was the US exceptionalism. People were anticipating the stock markets to go up, the dollar to go up, et cetera. And as a result, the US market cap, the total market cap was more than 70%, which was really, very large.

Paul Krugman: You mean, 70% of the world, and the US is only around a quarter of GDP, so that is really something.

Rey: Yeah, that was really huge. That was a very large share of the world market cap, which was a US market cap, right? And so after the so-called Liberation Day tariff announcement, we have seen something very unusual for a world reserve currency. We have seen that the dollar has gone down at the same time as equity markets are going down and also the US yields are going up. Usually we see the opposite co-movements when there is global turmoil or a massive uncertainty in world markets because usually the US dollar is seen as the safe haven. So we do see people wanting liquidity in dollars, and that props up the dollar exchange rate and we see the yields going down.

But we've seen the opposite co-movements. We have seen emerging market co-movements. And I think this is really the point where the world has reassessed in a way the confidence it had in the dollar as a currency because of the policies of the administration. And from then on, I think people have been down-weighting a little bit their position in dollars because of this reassessment. The breach in confidence [is] attached to what is happening with US institutions. I think this is very serious. It's not only the tariffs, it's everything else.

Krugman: Okay, I think I agree, but your story is basically that the world was holding a lot of US assets in general, and now we're not sure that America is still America.

Rey: Absolutely.

Krugman: So, I'm going to ask a strange question. When were you last in the US?

Rey: I was last in the US just a few months ago to give some seminars.

Krugman: And do you worry at all about visiting? Because I know some European academics who are actually concerned because you never know what's going to happen at immigration.

Rey: I actually do [worry] and I also know a lot of academics who do because we have all these stories and it's very hard to assess the probability of people being stopped at the border and having their phones looked at, their social media presence being investigated. And we have seen a lot of these examples of people being arrested on the street for very unknown reasons, essentially. It looked very arbitrary to us. So yes, I know a lot of people in the academic community are actually worried.

Krugman: Yeah, I won't say who, but I know some academics who are required by the nature of what they do to go back and forth. They're European-born and they travel with burner phones now, just so they don’t have to worry about their phone being inspected and it being discovered that they have texted their friends saying things critical about Trump, which is amazing.

You've written a lot, and way back I wrote a fair bit about the international role of the dollar. I'd like to have your version of the international role of the dollar. What is it that we’re talking about? Because it's one of those subjects that has a lot of mysticism around it, and people talk about it a lot without quite understanding what it is they mean. So, what is the specialness of the dollar?

Rey: I think the specialness of the dollar has many aspects to it. That's a little bit of the difficulty. But I think it's important to realize that there are many aspects to it because they reinforce each other, all these different roles of the dollar. Obviously one very important role is as a medium of exchange in international markets. If we do foreign exchange transactions, a lot of the liquidity involves the dollar one way or the other.

If we look at debt issuance in international markets, there's a lot of debt which is issued in dollars. Obviously it's also a banking currency. If we look at countries pegging their exchange rate towards another currency, most countries would be pegging vis-à-vis the dollar. The commodities markets are also in dollars. And the reserves of all the central banks are mostly held in dollars.

So it's very easy to see how all these aspects are reinforcing each other. If you are going to intervene in foreign exchange markets, you're going to intervene in liquid markets. If people want liquidity in dollars, or if you are going to need the liquidity and you are an international bank, you are going to want dollars. So everything kind of reinforces the role of the dollar, which makes it a very, very important liquid asset to have by many private and official players in international markets. But what kind of implication does that have? Something I've worked a lot on is the so-called “exorbitant privilege” of the US dollar.

Krugman: So why don't we come back to that in a second, because I want to say something for readers about the “medium of exchange.” It's a little bit like how we have a handyman coming later this afternoon. We're not going to ask him to fix our lights in return for a lecture on economics. I sell whatever it is I have to offer for dollars and use the dollars to pay the handyman. And the dollar kind of plays that role between currencies. So I always like to say, if you want to exchange Brazilian reais for Malaysian ringgit—and I always use that because I like the sound of the currencies—you don't look for somebody wanting to make the matching trade. You do it by selling one currency for dollars and then using dollars to buy the other. And you're saying that all of these things, that they're all of these different roles, but they’re all kind of mutually reinforcing the dollar you use for everything. And yes, exorbitant privilege. So that's a famous phrase, usually misattributed to Charles de Gaulle.

Rey: Right. Yeah. So, in fact, when I started to work with Pierre-Olivier Gourinchas on exorbitant privilege, we were desperately looking for the speech of Charles de Gaulle in which he would have quoted or talked about exorbitant privilege, and we could not find it. But what we did find after extensive research is that his finance minister, who at the time was Valéry Giscard d'Estaing, talked about exorbitant privilege in one of the press conferences he gave.

Nevertheless, I think the inspiration behind the idea of exorbitant privilege was definitely coming from de Gaulle, or Jacques Rueff who was one of the economic advisors of de Gaulle at the time. By that, they meant something quite important, which I think is still extremely relevant today. They meant that the dollar was an important medium of exchange, but at the same time, they called it a means of credit in the sense that people wanted dollar liquidity precisely because of all these roles that we have talked about. Everyone wants dollar liquidity and therefore the US could always issue short-term liquidity US treasuries that the rest of the world wanted and use this money to buy risky assets, to buy companies in Europe, in particular. So to buy assets that would earn a higher return and then refinance at cheap rates because they were issuing this liquidity that everybody wanted.

And that's something that De Gaulle resented and thought that was really an important privilege of the United States, which it is. And in fact, we computed the excess return that the US earns on its assets. So all the external assets that the US purchases. For example, if the US purchases companies in Japan or equities in Europe, these are the external assets of the United States. It earns returns on these external assets. And we compared the return on the external assets to the returns on the liabilities that the US pays and a lot of the liabilities of the US are going to be these US treasuries that the rest of the world is happy to hold. And so there is an excess return that the US has on its external assets compared to external liabilities and this is what, with Pierre-Olivier, we called the exorbitant privilege and we put a number on it.

Since the 1950s, it's about 1.5% in real terms per year, which is not a small number. But I would add another thing to the exorbitant privilege of the US, which is the fact that in bad times, people want dollar liquidity. Therefore, the US can refinance in bad times very easily. It doesn't face any sudden stop unlike in emerging markets. And it can refinance relatively cheaply in bad times, which is a very important aspect for financial stability and gives you a lot of leeway for your fiscal accounts, for your external sustainability, et cetera, et cetera.

Krugman: So again, for readers, the sudden stop, which is when money is flowing in and everybody thinks you're a great place to invest and then all of a sudden they kind of change their minds and the inflow of capital just dries up. Companies can't refinance, the government sometimes can't refinance and terrible things happen. That's what happened to Greece. It's what happened to a large extent to Spain and Portugal in 2010. It typically happens in Latin American countries. And the United States has always been immune from that. And what you're saying is that this is a really big deal.

Rey: This is a really, really big deal, yes. And also, there is a really self-fulfilling dimension to that aspect in the sense that since everybody kind of knows that the US dollar is a reserve asset and everybody expects other market participants to buy dollars in bad times, well, there is an appreciation of the dollar, which is linked also to these beliefs that everybody is going to buy dollars and therefore I also [must] buy dollars.

And that means that this insurance aspect of the US dollar in bad times is partly due to the credibility of US institutions and partly due to the belief of everyone thinking that people are going to buy dollars in bad times, therefore the dollar will appreciate and the dollar appreciates as a result. So when you are in such an equilibrium, both because of that and also because of all the things we said about the medium of exchange and the liquidity of markets, it's very costly for any individual participant to deviate from such an equilibrium and say, “Why don't I consider that I should use the Malaysian ringgit as international currency, or even the Swiss franc as an international currency?” If a lot of people are using the dollar, then deviating from that equilibrium is going to be very costly for any individual country or any individual player. So this is why it’s kind of stable.

Krugman: So it's actually interesting because the de Gaulle or Giscard d'Estaing version is actually a lot more sophisticated than what a lot of people think exorbitant privilege means. A lot of people think it means that the US can print dollars and the world has to take them, which is mostly not true. It is true that there's something like $800 billion of $100 bills circulating around the world being used by criminals. Although there's quite a few large denominations of euro notes now playing that role too.

Or they think that only the United States can run persistent trade deficits, which is also not true. Other countries do that as well. But you're saying it's very much about the ability of the US to be kind of the hedge fund or private equity nation that we can borrow and then buy up assets. And so they always have to use the dollar.

Rey: Absolutely. Or you could say it's a world banker, right? Because that's what a banker does, as well. It's kind of issuing safe assets and betting long in risky projects like, you know, buying companies, giving loans to companies. So, earning higher returns on the asset side of a balance sheet and refinancing at relatively low cost because it's issuing safe liabilities. That's what bankers do and that's what the United States does. And that's why it's sometimes called a world banker. If it brings more leverage, it's more like a world venture capitalist or a world hedge fund, if you like. Yes, absolutely.

Krugman: And yeah, there's also the fact that when the Argentine peso drops they have a lot of debt in dollars and assets in pesos and their balance sheets get much worse and this is an important part of a financial crisis. When the US dollar drops, we have a lot of debts in dollars and a lot of assets that are in other currencies. So our balance sheet actually improves. The special role of the dollar kind of insulates us and has made us a safe haven. Okay, and what you're saying is that it's very, very hard for any individual player to deviate.

Rey: Absolutely.

Krugman: That the incentives to stay are overwhelming.

Rey: Yes, and there several aspects to that, by the way. There is the liquidity aspect, which is like when we speak a common language. If everybody speaks English, then we are not going to deviate from speaking English because, you know, it's hard to learn another language.

Krugman: I want to mention that there's a wonderful essay by Charlie Kindleberger about the role of the dollar as an international currency and the role of English as an international language, saying that they're very parallel. And we are, of course, speaking neither in French nor in Mandarin, but in English. So…

Rey: Absolutely, but we used to speak French, you know, because there was a lingua franca in the old days, but we switched to English mostly. So yes, this is very similar in terms of network externality, in terms of this liquidity and medium of exchange. But there are also other aspects. A lot of the banks and intermediaries in the world use dollars. That also means, by the way, that the Federal Reserve has a disproportionate effect on the financial cycle in the rest of the world. And in fact, I've also done a lot of work on the global financial cycle. And if you look both at the role of the US Federal Reserve and also at US macro news, you can explain a lot of the movements in financial markets worldwide, in the global financial cycle. So that's also something that goes together with the international role of the dollar.

Krugman: Yeah, that's interesting because Jerome Powell and Christine Lagarde have basically, if I'm getting that right, the same job and oversee comparable sized economies, but somehow Powell matters a lot more.

Rey: Yes. And US macro news tends to matter more as well. Absolutely. If you look at world asset markets, yes.

Krugman: Okay, but these are extraordinary times. If suppose we just posit that somehow or other the dollar's role could unravel, what would that look like? What do you think would actually happen if things started to fall apart for the dollar? Would it be an alternative currency? Would it be that there is no international currency? How does this all play out?

Rey: Well, first of all, let's not put that as a forecast, right? Because I do think we see a kind of rebalancing out of the dollar, but it is a relatively slow rebalancing out of the dollar. It's because people were overweight in dollars. And so there is some reconsideration, which is due to this lack of trust that we talked about earlier. But we do not see for the moment anything that looks like an abrupt rebalancing of portfolios and essentially massive capital flight out of dollar assets. We don't see that. For that to happen, we would have to have a credible alternative; another credible currency in which large amounts of capital flows could fly into. And we don't have that.

What do we have? Well, we do have a second most important international currency, and that's actually the euro, right? So if we look at all the statistics about international currencies, we see statistics on international reserves of central banks, whether we look at debt issuance or whether we look at payment systems, Swift data and otherwise. If we look at in general foreign exchange turnover, we do see that the euro comes second, but it's a relatively distant second.

And then there are other currencies such as if we think about the RMB, for example. The RMB is absolutely not integrated in world financial markets. So it's very, very distant in terms of any statistics for the RMB compared to the euro and the dollar. So the euro is the most credible in terms of international currencies.

Krugman: Right. Again, for readers, RMB is renminbi, otherwise known as the yuan, the Chinese currency.

Rey: Sorry, yes, the Chinese currency. And if we look at the yen or sterling or a Swiss franc, they would also be relatively small in terms of international presence. So it's definitely the dollar first, far ahead, and then the euro. So what about switching into the euro? Well, there is the issue that if we look at the debt market, the bonds market, which are very important for the international role of the dollar (as we discussed with the role of the US treasuries, which is pretty fundamental as a reference asset, the dollar liquidity being used by everyone essentially, banks or market players, etc.) Unfortunately for the euro, we don't have the equivalent in terms of a euro-area bonds market which would be as liquid, as broad in terms of financial instruments, with all the financial ecosystems that would support a more important role of the euro as an international currency.

So the question is why not? As you said, if we look at the size of the euro area, okay, it's not as large in terms of GDP, but it's very large and there are pretty sophisticated financial markets there. However, the euro, as you know, is a currency which has 20 countries behind it. It has a very, very credible central bank, the European Central Bank. It has very solid institutions behind that central bank. It also has very good supervision in terms of microprudential policies and macroprudential policies. But it doesn't have a unified fiscal authority behind it. It has 20 essentially finance ministries, the 20 budgets behind it. And therefore the bond market is still segmented. A Bund, a German bond, is not the same as an Italian bond, for example, or a French bond. And therefore what we see in times of stress or what we have seen in the past has been, if we have flight to safety, we have a segmentation of the euro area bond market, people going into some bonds and going out of a number of other bonds. And so the spread between the bonds widens, which is not a good characteristic for a bond market. So we are still stuck with this.

Krugman: Yeah, I remember circa 2007 or so, people were actually talking pretty seriously about the euro as a rival to the dollar. And at that point, everybody said, “Well, it's all euros. It's all safe.” And basically, Greek interest rates were about the same as German interest rates. And then all of a sudden, that wasn't true. And that really fragments it.

Rey: Yes, so we have seen the euro area crisis during which that fragmentation was extreme and we had a problem with so-called doom loops between the each national banking system and the sovereign bonds of the banks. So for example, there was a vicious circle between the sustainability of a banking system in Spain and the sovereign debt of Spain. Evidently the banking system was very big compared to the budget of the sovereign for Spain. Or, for example, Ireland. And so you had this kind of bad interaction between the banks and the national debt, which fragmented the bond market very much during the euro area crisis in around 2011, 2012. And then we had this intervention of Mario Draghi, the famous, you know, “we'll do whatever it takes and it will be enough.”

Krugman: Yeah, so people may not know this. It’s the sudden stop thing where capital movements into Spain and Portugal just stopped. The capital stopped flowing and it was a crisis and there was a lot of anguish, like, “God, these countries are bankrupt. It's hopeless.” And Paul De Grauwe, the Belgian economist said, “No, this is not a solvency crisis. This is a self-fulfilling panic. And all we need is for people to be assured that they will get their money.”

And then Mario Draghi says three words: “we will do whatever it takes and it will be enough.” And he didn't get the authority to say that. And in fact, they never actually did put up any money, but that kind of ended the crisis. Amazing thing.

Rey: “And it will be enough.” Exactly, that was an absolutely amazing power of the word of a credible central bank because there was never any bond purchase. And yet, as soon as he said that, the spread started falling and the Euro-area crisis became better. This said, there was also the construction and building up of institutions which are still with us. Like the European Stability Mechanism, for example, and various intervention tools the ECB has built over the years, which makes the euro area a lot more resilient than it used to be in 2010. So there has been a lot of progress there. And there has also been joint supervision constructed for big banks. And there's also the construction of a build-up of macroprudential authorities in each country of the euro area, which are there to deal with systemic risk. And that's also a very important tool that the euro area has, which is actually stronger in the euro area than it is in the United States: the possibility of using macro-prudential policies to deal with systemic risk.

Krugman: So again, just need to bear in mind that we have a highly intelligent but not necessarily technical listenership / readership here. “Macroprudential” is basically a way of saying that we don't just worry about the fact that a bank may have made bad loans. We worry about the fact that a bank might find itself in a bad environment because there's a crisis. And you try to at least have some limits on the risk to which it exposes itself. I think that's a fair description.

Rey: Yes.

Krugman: And those prudential moves are a lot stronger in Europe than they are in the United States.

Rey: They are. The macroprudential tools in the Euro area level are pretty developed. And so they really look both at the big banks and at the interaction of the banks with hedge funds, with insurance companies, with any other market participant there that may cause some financial systemic risk. And so the interactions of all these actors is being looked at carefully.

So that puts the euro area maybe in a stronger position to deal with the volatility of capital flows, which has been an issue. In particular, you talked about Spain and Ireland, and that was a general issue. So that robustifies the system. The system is more robust because of the availability of these tools. Plus the independence of the ECB is actually enshrined in the treaties. So it's actually a very, very independent central bank from the point of view of institutions. Therefore it's a very strong set of institutions that support the euro area.

Krugman: We tend to think of the US as having all of the strong institutions, but at this point, as you say, the ECB is by treaty, more or less independent, whereas with the Fed is, the current president is constantly threatening to fire the chairman of the Fed, and will get to appoint the next one. And there’s sort of an informal betting pool on how bad will the next guy be, and that's not going to an issue in Europe. So on the institutional basis, Europe and just it's kind of rule of law would seem to have all of the advantages of the United States but what you're saying is that the inertia of the fact that the dollar is the international currency still trumps that, which turns out to have a double entendre that I didn't intend there, but anyway.

Rey: Yeah, there's the inertia and the fact that there are still 20 budgets behind the euro and we don't have much common debt issuance. In particular, if you add up all the issuance of debt that we have had at the European Union level, it's up to a bit more than one trillion dollars, or not that much more. While if you take, for example, the US Treasury markets, it's already like 30 trillion dollars.

So, definitely there is a big disparity in terms of the depth of the debt market if we compare the US Treasuries to EU issued debt or debt that can be considered as common debt. Then there is obviously all the national debt [of each individual country], but as we said, the markets there are still not integrated. So that's still an issue with market segmentation for the euro.

Krugman: Yeah, and the thing is it's not just that Spain has its own debt and Spain could get into trouble and there's no one backing it up. It's also that when we have regional problems in the United States, there's a lot of automatic compensation. Social Security, Medicare keeps on flowing while tax payments to Washington fall. So we give kind of de facto aid to troubled regions on a scale that would be inconceivable. Germany would never agree to give Spain as much aid as Florida in effect got after its housing bubble burst. So yeah, in Europe you basically have everything going for you except not being a nation.

Rey: Right. We don't have a big common budget at all. The European budget is very, very small as a proportion of GDP of Europe, absolutely. But, you know, we have had more joint programs as time has gone by. We've done a lot more things for COVID, for example; things that were almost considered impossible a few years ago. So things have been moving forward, but it's slow, obviously.

And now we have a lot of big challenges because geopolitics has changed a lot. So now we have to talk about common defense. And this is something that was quite taboo because of Germany for many years. But now things have changed a lot because of Russia and Ukraine, and also because of the US administration acting as an incentive for Europe to increase sovereignty. So there is lot more talk about sovereignty in defense, and in payment systems, which are also very important. There is a lot more talk about the role of currencies. The dollar has been dominating payment systems worldwide. And a lot of the credit card transactions in Europe, for example, they go almost systematically through American companies: Visa, MasterCard, PayPal, Apple Pay, and others—they are dominating the credit card payments. And that's considered less and less acceptable in the euro area. So there's a lot going on there.

Krugman: So, a few minutes ago, you did mention Swift, the interbank payment system, which is based in Belgium, but in practice, I think basically answers to the US government.

Rey: So, it's a messaging system and it is indeed based in Belgium, but the data is very much available to the US government. All of these payments generate data which becomes increasingly valuable. And I think that's going to be one of the key [movements] happening in the coming years because we're also changing technologies in terms of payments.

We are seeing not only the geopolitical threats becoming much more acute, but we're also seeing the emergence of new technologies, a lot of cryptocurrencies. We’re seeing US dollar stable coins being pushed by the United States. And all of that is generating central bank digital currency, all of that is generating data. Data is very valuable. And we're also seeing that payments are very important when you're thinking of imposing sanctions, for example, right?

So there is a strategic value of all that. And given the geopolitical environment, this is increasingly crucial. So for Europe, that's also going to be a very important part of European sovereignty. There's no doubt about that.

Krugman: Why don't you give me your definition of a Central Bank Digital Currency, or CBDC, which always sounds to me like a 70s punk rock club, but anyway. And then let's talk about that for a second, because I think there's an interesting story there.

Rey: Right, so with central bank digital currency, there are different kinds. First of all, few exist already. There's just a couple of countries who have introduced CBDCs. Some have been introduced as pilot schemes, for example, by the People's Bank of China. But the European Central Bank has been working on a CBDC. But there are different types of CBDC. You can have a retail CBDC, which would be for you and me, for example. That would mean that we could have essentially an account directly at the central bank. Currently the only people who have accounts directly at the central banks are the commercial banks. Individuals like us, we don't. So that would be a retail style CBDC and we presumably we could make payments with each other. In different countries of the euro area, we could avoid Visa and MasterCard and use that retail CBDC to make our payments. Currently we can't do that. We have to go through some kind of payment provider.

But there's also a wholesale CBDC that would be for financial intermediaries. For example in the euro area, we do have something already that is essentially akin to a wholesale CBDC because we have quite a highly performing settlement system, a continuous time settlement system, which involves the settlements of payments instantaneously. But what is being worked on by the ECB or thought about is to integrate with already existing wholesale payment systems with digital ledger technologies—essentially different types of distributed ledgers—so, blockchain style things that people may be willing to use to do some programmability with some different functions for different cryptocurrencies, etc.

So right now the wholesale system of the euro area is not integrated with these new types of distributed ledger technologies that some people may want to use. So the question is, should we integrate them? How do we do that? Do we make the wholesale CBDC compatible with some DLT, some distributed ledger technologies? How do we do that? How do we assure interoperability? These types of things. So these two aspects currently in the EU area, the wholesale CBDC and the retail CBDCs are being discussed, looked at, and there are already some pilots being run. So this is really something which is at the center of policy makers’ interest as we speak, especially because of what is going on in the US, which is very different. Pushing for US dollar stable coins with the GENIUS Act and actually pushing against a US dollar CBDC, a central bank digital currency by the Federal Reserve. So it's a different type of action that has been decided by the US government compared to what is happening in the euro area where, mind you, we still need political decisions to be made, et cetera, for all these pilots by the ECB to be put into effect.

Krugman: Yeah, the same week that the House passed the GENIUS Act, they also passed a bill not only forbidding the Federal Reserve from introducing a CBDC, but forbidding it even to think about it. They must not study the possibility of a digital currency. So we're following a very different route here. I actually wonder whether, at some level, the fact that all of the sort of private payment systems like Visa, MasterCard, PayPal, and so on, being American may be an advantage for Europe because you don't have the same interest groups blocking the possibility of actually creating this potentially quite efficient central bank run system.

Lastly, one of the things that certainly some people I talk to worry about is not that something replaces the dollar but that nothing does, that we enter a world in which there is no universally safe asset. Right now, a three-month U.S. Treasury bill is, I was going to say the gold standard, but it's better than gold. A US T-bill is the ultimate safe asset, so much so that sometimes interest rates go negative because people are required to hold them as collateral. But that could be undermined if you have sufficiently crazy U.S. policy, which certainly is possible. What happens to the world economy if we get that kind of disruption?

Rey: I think there are several aspects to the question. I think one of the positive aspects of the US dollar as an international currency is precisely what Kindleberger was describing as the provision of a global public good for the world economy. Because this idea that if you use the same language, like you use the same currency, you can do transactions with less risk, things are more stable, transaction costs are lower. But also, there was this idea of stability and this goes with a reserve currency and these co-movements of asset prices that we discussed earlier: the dollar going up in bad times, the refinancing in dollars being possible and therefore you can have counter-cyclical capital flows coming from the financial center. This is also the role that sterling played during the gold standard period before Bretton Woods.

So there is really a kind of global public good aspect of having an international currency. This is the theory of hegemonic stability of Charles Kindleberger. And when we don't have that, what does it mean? It means that we have a bunch of smaller currencies, which actually, given what we said about changing technology, could also include privately issued currencies, right? All of these currencies have different degrees of credibility. So they are partly substitutable. So you can switch portfolios from one of these currencies to the others, but none of these currencies are fully credible. So that means that when there is a shock, you may have a very abrupt portfolio shift out of one of these currencies for another currency. So that can create a lot of volatility. And this is reminiscent of what people have considered to be one of the most unstable periods in monetary history, which is the interwar period where you had portfolio shifts between sterling, dollar, Deutsche mark, French franc, et cetera. And here this could be a lot worse because if you don't have credibility in the US dollar anymore, you have the euro, which is there as a kind more regional currency. Then you will have the emergence to some extent of some other currencies such as the yen, the sterling and the RMB.

But also you will possibly have all these US dollar stablecoins or maybe euro stablecoins depending on how well they are backed. Depending on the regulation of these things, the credibility, you have Tether, for example, which is a stablecoin which is supposed to be one for one with the dollar, but you don't exactly know what kind of assets are backing this peg vis-a-vis the dollar. So you can see the multiplicity of all these actors. All of these actors have an incentive to get more seigniorage. So that may lead back a little bit to the private banking world of the 19th century [when there was] quite a bit of instability and a very fragmented landscape. [This would bring a] very big loss in efficiency and also potentially a lot of financial instability.

Now I would add one thing. We know that this private money, may be financially unstable because of fundamental issues such as what are the assets backing them, what are the institutions backing them, etc? We have seen that in the past with very non-credible monies being issued and sometimes runs because of the lack of credibility. But there is an additional layer in terms of risk coming in with this crypto money, which is the problems with cyber risk, hacking risks. It's becoming even more salient, more important. The data, the integrity of the data of the blockchain in a world in which quantum computing is likely to emerge and to be able to break public keys of a lot of these blockchains. So if you think that some currencies are more hackable than others, then you're going to get a run on those as well. And that's very, very risky, right? I mean, that introduces another level of risk in this monetary landscape.

Krugman: Yeah, actually, just thinking of this on the fly here, if you had a euro CBDC, you have an account at the European Central Bank, and somebody hacks it and steals $50 million from your ECB account, presumably the ECB would say, “Oof, we're sorry about that,” and they'll make it good. Somebody made off, but it'll end up being Frankfurt that pays the cost, not you. But if somebody hacks a private currency and steals your funds, that's your problem. That's actually kind of a further stability risk.

Rey: Yes, I think the legal underpinning of a lot of the crypto world, we don't know about it. It's not there. What is the governance of these ledgers? What guarantees what happens if you are hacked? Well, we don't know and it's very hard to figure out what the governance is going to be. So this is definitely a huge risk that, in my view, people are totally underestimating at this stage.

Krugman: So that's a big deal. Actually, this is entirely new to me. I think a lot about risks of the world economy. I was actually invited to write a paper about the risks of a collapse of the international role of the dollar in 1980. So, this concern has gone on forever. But I had never actually thought at all about how cybersecurity and hacking has now suddenly become a really big issue.

How are you feeling about the future? And why don't we close there?

Rey: Well, being based in Europe, I am hoping that Europe will be a little bit more proactive about its own future. And usually, we always say in Europe that because that was the view of Jean Monnet, that Europe progresses when there are crises. I do think that we are in the middle of a big existential crisis for many reasons, but that Europe has a lot of values that it needs to promote and protect. And in a world in which multilateralism and cooperation are losing ground every day, and in a world in which we have essentially war threats on our door, that tells me, it's very important to build a European defense. It's very important to strengthen the euro, to strengthen payment systems, to keep on the environmental policies that Europe has been a leader in. And actually, I think that would be an interesting area for the euro to gain ground, to be more important for commodities markets linked to electrification.

The dollar has become very important in all the oil markets, in all the old energy markets, essentially. But now we are moving on to a world where electrification is becoming extremely important. There's a whole host of new minerals which are involved in this. So Europe could take more of a lead there and presumably, the euro should be a more important currency in those markets. So I think we should work in these areas and make sure that the human capital in Europe is put to good use and invest a lot more in the future. This is very difficult obviously in a situation in which the debt to GDP levels are quite high. So I'm not sure exactly how we are going to navigate this, but I think it's extremely important that we work on it. So, yeah, that's my feeling right now.

Krugman: It’s good to hear you saying that because, as an American who's very, very worried about what the hell is happening to my country, Europe is in some important ways a backup for the values that we believe in. But I think I'll stop it there. Thank you so much for talking with me.

Rey: Thank you so much Paul, it's been a lot of fun.