Special Global Outlook 2026 - We need to talk about Exorbitant Privilege

(I) America’s Turning Point – When institutions fail

Rogier Quaedvlieg

On 24 January, 2025, four days after the new Trump administration took office, seventeen inspectors general, many Senate-confirmed guardians of executive accountability, received dismissal notices via email. In one swoop, oversight roles that had long constrained agency excesses were stripped of their defenders. That purge set a tone. By late September, a federal court would rule several of those firings unlawful, yet decline to reinstate the dismissed officials. Just some days earlier came the indictment of former FBI Director James Comey, raising significant concerns that prosecutorial discretion was being abused for the purposes of political theatre. Around the same time, the CDC was hit by sweeping layoffs and structural reorganization, and massive proposed budget cuts. During the government shutdown, whose fault is being publicly put on the Democrats on all official government channels, layoffs were extended to the Treasury, the departments of Education, Commerce, Energy and many others. During the same shutdown, where furloughed federal workers are not getting salaries, and the SNAP program for food support was put on hold, the White House started construction on a massive ballroom, supposedly funded by private donors to circumvent the shutdown. These moves, grim in isolation, gain deeper meaning when placed side by side: they form a narrative arc of institutional retrenchment, one in which oversight is hollowed, enforcement becomes discretionary, and public goods are dismantled.

These are not anomalies, and we raised concern on this possibility a year ago. They gesture toward a broader blueprint: Project 2025. The policy agenda backed by many in the Trump circle proposes sweeping executive powers, reorganization of federal agencies, expanded ability to fire civil servants, and decentralization of certain regulatory functions to partisan appointees. Its architects argue that the existing administrative state is bloated, unaccountable, and ripe for overhaul. Its critics warn it is precisely the toolset for converting partial capture into full control. Indeed, on October 9th, Stephen Miller, the White House deputy Chief of Staff slipped that Trump has ‘plenary authority,’ in a CNN interview, which represents power in absolute terms, with no review of or limitations to exercise that power.

The White House is firing watchdogs, prosecuting political adversaries, dismantling oversight, and reorganizing agencies in deeply partisan ways. When institutions that once limited power become subject to it, they cease functioning as guards and become tools. This raises the question whether in three years’ time, this will still be the America of rule-bound, plural institutions and robust markets, or whether it will move towards a model where the US institutional balance tilts, perhaps irrevocably, towards a more extractive model. The risk is not only political, but also economic, and the stakes are high.

To understand the short and long-term implications, it’s enlightening to look at these developments through the lens of Nobel Laureates Acemoglu and Robinson’s ‘Why Nations Fail,’ in which they argue that it is not geography or culture that determines economic outcomes, but the nature of political and economic institutions. Inclusive institutions that spread power, enforce rule of law, protect property rights, and foster creative destruction, generate sustainable growth. By contrast, extractive institutions are structures that concentrate power and wealth in the hands of a few, limiting opportunities for the majority and hindering economic growth. The key insight: institutions don’t just shape growth today, they shape incentives for investment, risk, innovation and social trust tomorrow. Once the machinery shifts toward extraction, reversing the course becomes painfully difficult.

What It Might Mean for America’s Long-Term Economy

If the United States leans toward extractive institutions, the consequences will be structural and persistent, although it may take many years for the impact to be visible. The greatest threat to long-term growth comes from the fact that uncertainty over rule enforcement impairs long-duration investment more than short-term flows, skewing capital away from productivity-enhancing, long-horizon projects. Productivity and innovation suffer through two channels: (a) a direct cut to public goods (R&D, data, public health surveillance) degrading the inputs for private innovation; and (b) reduced incentives to invest due to weaker property rights and unpredictable regulations. Declining innovation reduces potential output growth and raises structural unemployment risk over time.

Second, as we have already seen (be it temporarily), policy uncertainty and risk premia would rise. When enforcement is perceived as discretionary or politically motivated, firms and investors price an added governance premium. That premium shows up as higher borrowing spreads and greater discount rates for government debt and government-sensitive sectors such as finance, regulated utilities and health care.

We should also expect fiscal and, the elephant in the room, monetary policy implications. Politicization of agencies and pressure on independent institutions can bleed into fiscal policy. They could lead to preferential bailouts. This could be a bailout of companies (an AI bust scenario comes to mind, where companies that have shown support to the administration are bailed out to continue the AI race with China), or of politically aligned sovereigns (such as the USD 40 bn dollar that was sent to Argentina). The negative impact of a lack of central bank independence requires a chapter by itself.

Another, less visible, effect is that public-goods capacity withers. Institutions like the CDC, NIH, regulatory science offices, environmental agencies and oversight bodies deliver returns mostly when crises occur. If they are hollowed out, resilience falls, and shock responses become weaker and costlier.

In an international setting, the US risks losing its exorbitant privilege. That America of rule-bound, plural institutions and robust markets is the reason that the US has grown to the economy it is, and the reason that the whole world continues to look at the US as the primary place to invest. That willingness to invest supports the dollar, and depresses interest rate spreads. The privilege is the envy of many other economic superpowers, and they should be jumping at the chance to replace the US in this global position.

Reversing the trend is hard. Once institutional norms are broken and careers reshaped, rebuilding independent agencies, judicial integrity, and oversight cultures is harder than maintaining them. The US risks sliding into institutional lock-ins characteristic of many weaker states, where political power trumps rule-based governance.

(II) Laying the groundwork for a European safe asset

Sandra Phlippen and Nick Kounis

When the US administration introduced global tariffs in early April of this year, the negative co-movements in the value of the dollar and US equities, while Treasury yields rose, signalled a reassessment by global investors whether the dollar was to be trusted as a safe asset. The depreciation of the dollar seen this year does by no means reflect or predict a fundamental loss of confidence in the dollar reserve system (see our note on the dollar here). However, the decline in US institutions has continued at a high pace since the beginning of the year and the question of how trustworthy the dollar system still is, cannot be completely ignored. In this respect it is worth noting that the exorbitant privilege of the dollar system consists of many self-reinforcing layers. Once these layers start unravelling, the dollar system and with that global financial stability could be at risk.

Whether it is to avoid the risk of global financial panic or to grasp the opportunity of the century, preparing a European safe asset can be considered a no-regret move. Getting to such an asset in a euro system with many fiscal authorities is easier said than done, but we judge that a first step can and should be taken now through what is known as a blue-red bond scheme, which could allow for the creation of a European Safe Asset of with a market size of around EUR 4.5 trillion.

Capturing the exorbitant privilege

The dollar has many functions. Besides being a medium of exchange and the preferred currency for debt issuance, pegging local currencies, and central bank reserves, the dollar system also functions as means of credit. This is because the US can issue cheap dollar denominated debt and invest in foreign assets. According to research by Gourinchas and Rey (see here), the returns on foreign assets minus the costs of debt have led to an advantage of around 1.5 % of US GDP per annum in real terms since the 1950s. Another unique advantage for the dollar is that in times of stress, everyone wants dollar liquidity. As a result, refinancing costs in bad times are relatively low for the US and even lower as the world expects everyone else to flee to the dollar for safety. All these advantages rely on the US being a trustworthy counterpart. The risks of our times is that when markets get stressed precisely because the US is faltering, there is no safe haven to flee to. And this is where the Euro comes in.

The decline in US institutions could be an opportunity for Europe to increase the euro’s global prominence, but it requires to prepare the Euro system to perform this role if needed. The euro is currently the world’s second currency to the dollar, but very much a distant second. For instance, the euro accounts for 20% of global foreign exchange reserves, compared with 58% for the US dollar. To boost the euro’s role, the eurozone would need to strengthen its geopolitical influence, make its economy more dynamic, strengthen the economic union and perhaps most crucially foster deeper and more liquid capital markets.

A key ingredient of achieving this is having a safe asset of sufficient scale. Although Europe does have safe assets, none of the markets have the size necessary. To give an example, the German government bond market has an outstanding size of around EUR 2 trillion, while NGEU bonds around EUR 0.7 trillion. This compares to the stock of US Treasury market securities that sits at USD 30 trillion. This has led to many calls over time for the creation of a Eurobond market.

The most complete version of a Eurobond market, that would achieve the biggest scale is one where all eurozone sovereign debt is mutualized. Outstanding government bonds in the eurozone stand at around EUR 11 trillion. So this would certainly represent sufficient scale. The obstacles to this occurring, certainly in the next few years, are large. First of all, this is not something that can occur under the current institutional arrangements. Member states would need to given up a much greater degree of sovereignty in terms of fiscal policy and governance structures for this would need to be set up at the eurozone level. Although the fiscal rules have been strengthened, they would be too weak in the context of common issuance. Second, treaty changes would be needed. Third, and perhaps most importantly, there does not seem to be the political support for such a further large step in economic integration either on the government level or the public level.

A first and important step to a Eurobond market

However, the are other intermediate options, which might may overcome the above obstacles. The most straightforward of these is that some proportion of current eurozone national sovereign debt is pooled into Eurobonds, while the rest remains national. There have been various versions of this so-called blue-red bond plan (originally proposed in the early days the euro crisis in a Bruegel paper by Delpla and Weizsacker – see here). More recently, Blanchard and Ubide (see here) set out a variation of this scheme, which we use as a framework for what follows. The pooled blue bonds – the Eurobonds – would have seniority to the remaining red or national sovereign bonds and each government would be responsible for their part of the debt. The red bonds would then be junior and their credit quality would dimmish. The resultant higher interest costs on these could be a disciplining force when it comes to countries running responsible fiscal policies.

A too large proportion of blue bonds would undermine their credit quality and raise issues about risk sharing. A too small proportion may mean the market is not deep and liquid enough. So optimizing the size is important. As an example, we consider a proportion of 30% GDP of national bonds switching to Blue bonds and limit the market to eurozone member states. This would mean the Blue bond market would total around EUR 4.5 trillion. The scale could be enhanced by potentially replacing existing European supranational bonds (amounting to around EUR 1.5 trillion) with Blue bonds. This would not be straightforward however given that the credit structure differs for different bonds. An alternative solution would be to push up the proportion of Blue bonds, while still maintaining their credit quality, by countries committing certain tax revenue streams to repayments. However, this too might be tough politically.

This raises the question of how big is big enough? It is likely that at EUR 4.5 trillion, the market would be deep and liquid enough to be categorised as a credible safe asset that would help the development of European capital markets. It would also easily be included in sovereign indices, especially given that there would no end in sight, unlike the case of the NGEU market. However, it would unlikely be of a scale to challenge the dollar’s dominance. Total global foreign exchange reserves amount to USD 12.5 trillion and foreign official sector holding of US Treasuries total around US 3.9 trillion. Considering the proportion of government bonds that reserve manager hold in their portfolios (generally estimated be around two-thirds of the total) and given their reasonable share in total Eurobond holdings, the Blue bond market would need to be considerably bigger. We estimate that to be a dominant safe asset globally, the scale of the Eurobond market might need to be around EUR 8 trillion. So a switch of 30% GDP of national bonds to Eurobonds would not get Europe there. Still, it would be an important step with significant benefits and one should not let the perfect be the enemy of the good.