Europe’s leaders are getting excited by the idea that Donald Trump’s erratic policymaking is going to hasten the end of U.S. dominance of the world’s financial system, but their meeting on Thursday will remind them how far they still are from being able to exploit the situation.
In his invitation to national government heads, European Council President António Costa said the meeting would be “a good opportunity to consider how to further strengthen the international role of the euro” — code for the long-term goal of making the euro a global reserve currency to rival the dollar.
Amid signs that the U.S. president has shaken global confidence in the dollar, some are seeing a rare opportunity to compete for the power and prestige that reserve currency status bestows. Europe’s comparatively sound economic policies and strong rules-based institutions could give the euro a competitive edge over the dollar, European Central Bank President Christine Lagarde said in a speech last month proclaiming “a global euro moment.”
However, the most obvious single step that would instantly make the euro more attractive to world investors is one that leaders have fallen out over many times before and are likely to again: large-scale joint borrowing.
“If Europe is going to offer investors an alternative, it needs to increase the size of the Eurobond market dramatically,” former International Monetary Fund Chief Economist Olivier Blanchard and Ángel Ubide, economist at Citadel, wrote last month in a joint paper, which has drawn much admiring commentary, including from senior figures at the ECB.
The paper revives a proposal first made in 2010 to divide the government debt market in two: all national government bonds up to 60 percent of gross domestic product would be swapped into ‘blue bonds’ guaranteed by the EU, while member countries would stay responsible for all the debt above that level (‘red bonds’).
In theory, this would allow Europe to create, at a stroke, a large, liquid pool of safe assets that would finally offer global investors a real alternative to buying U.S. Treasuries: something that offers a steady return with no credit risk, something they can hold forever or turn into cash in an instant if need be, somewhere to park their money while looking for the next big investment in stocks or real estate, something to use as collateral for their next loan. The absence of a large market for such assets today means that it is gold, rather than the euro, that has benefited from the dollar’s weakness since the start of the year.
This time is different?
Joint debt has long been an option for making Europe’s capital market more attractive and competitive, but it has always been contentious. During the eurozone sovereign debt crisis, leaders notably from Italy and Spain pushed for Eurobonds, trying to bring down their borrowing costs. It never happened because their frugal northern neighbors, led by Germany and the Netherlands, argued that that would leave them on the hook for spending they never approved.
The EU has tried to address such ‘moral hazard’ by creating and policing a set of rules that would cap national governments’ borrowing. But those rules were suspended during the pandemic and have only been restored in a fashion that is watered-down and hard to enforce.
Blanchard and Ubide argue that the world has moved on since 2010, and that the idea deserves another look. Ubide told POLITICO that Europe’s successful experience with joint debt during the pandemic suggests that this time may be different.
While Ubide recognized that “there will surely be a debate about immediate costs and benefits for some countries,” he stressed that the plan will benefit all countries over the medium run.
Certainly, the calls for more economic and financial integration have become louder than ever, as the extent to which a stunted capital market is hurting Europe’s broader competitiveness has become clear. As former Italian Prime Minister Enrico Letta argued in a recent opinion piece, “in a world in which economic power is increasingly weaponized through sanctions, trade restrictions and financial coercion, this is no longer just an economic issue — it is a question of sovereignty.”
The argument is getting some recognition in Germany and the other ‘frugal’ states, which not only backed joint debt issuance in response to the pandemic, but also approved the SAFE (Security Action for Europe) program this year. SAFE will allow the EU to issue €150 billion in new bonds to finance cheap long-term loans to member states for coordinated military procurement.
Old habits die hard
But even the new government of Chancellor Friedrich Merz stresses those were temporary and exceptional measures. And while Merz has radically adjusted domestic policy to new realities with a dramatic U-turn on Germany’s strict spending rules, that does not necessarily mean he will be equally flexible on joint borrowing.
A spokeswoman said that Berlin does not support proposals for blue bonds and sees “no reason for discussion of the topic” this week.
“Merz has already crossed a red line for the German conservatives by largely suspending the national debt brake,” said Berenberg chief economist Holger Schmieding. “This has already cost his party several percentage points of support and given the [far-right] AfD a further boost.”
A senior German government official did not rule out the possibility of more Eurobonds to finance spending on defense, a common public good, but he noted that that is an issue for negotiations on the EU’s next budget framework, starting in 2028.
Likewise, the current Dutch minority government has no appetite for anything radical on joint borrowing in the near term.
“The cabinet is not in favor of common debts for new [Eurobonds],” a spokeswoman said, adding that a large majority in parliament is also against the idea.
In the markets, meanwhile, frustration is mixed with resignation.
“We can continue to preach,” said UBS Investment Bank’s chief European economist, Reinhard Cluse, but “I’m not holding my breath.”
Nette Nöstlinger and Geoffrey Smith contributed to reporting
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