Cheat sheet for an EU financial geopolitics plan

Greetings and happy Brexit anniversary week. Everyone and their grandmother seems to have written a report to commemorate the affair; scroll down for my picks of the crop.

But first, a follow-up to last week’s Free Lunch. I reported on a debate about the future of digital money in Europe, and complained that “Europe lacks a geopolitical strategy for digital money”. But I neglected two things. One was to point out that Europe also lacks a geopolitical monetary strategy at all, beyond just the digitisation aspect. And more importantly, I didn’t get into what such a strategy should consist of. So today’s Free Lunch column makes some proposals for a would-be monetary geostrategist in Brussels, Frankfurt or elsewhere.

A European strategy for monetary geopolitics needs to have (at least) four parts, in my view.

First, of course, it has to join the battle for monetary attractiveness, in line with last week’s reporting. So the EU needs to seriously pursue the goal of making euro-denominated products attractive to the world, and not just in euro countries. Continuing work on wholesale digital settlement is a welcome part of this. But it also means bringing in the digital euro faster than current timelines, with higher holding limits (or ideally none at all) and with regulated but more generous access for non-euro area residents than what is contemplated today. The bloc should also be more encouraging of EU-issued, euro-denominated stablecoins, as set out in the Bruegel paper we covered last week.

In the same vein, EU institutions should embrace a role as a provider of international monetary public goods — mechanisms that help reduce risk and transaction costs through the use of the euro. As I have argued before, that includes a greater willingness to issue swap lines and refinancing facilities to non-euro countries.

The European Central Bank earlier this year beefed up its repo facilities for other central banks. That was an excellent step forward. But it can provide a further incentive to foreign institutions to favour euro-denominated securities in their portfolios. Ideas could include standing rather than time-limited liquidity lines and conditions that are attractive in “peacetime” rather than when crisis looms. Remember that the dollar’s dominant international role was boosted by the emergence of the “eurodollar” securities and lending market. The euro could similarly benefit from an offshore euro-denominated financial market.

Second, realise the monetary benefits of economic integration. A new paper presented to the Economic Policy conference last week suggests that both a deeper domestic market and closer trade and capital links with other economies increase the attractiveness of a currency. Conversely, protectionist withdrawals from the global economy, such as the tariff walls beloved by US President Donald Trump, make a currency less useful to foreign holders as a hedge against risk.

That plays into the euro’s hands. Trade liberalisation has long been in the EU’s DNA, so this is one pillar of geoeconomic policy that Brussels does naturally. And its ability to ink new trade deals in recent years has been impressive and welcome (although in some cases — such as with the Mercosur bloc — not before time, and still not unshackled from political uncertainty).

But a geoeconomic strategy worthy of the name would consciously link these first two strands, and use the trade agenda to advance the monetary agenda. Here is one illustration of how the EU can make its economic strategy more sophisticated. When the bloc negotiates trade deals, it could include talks on ECB swap lines as potential additional offers while confining preferential trade concessions invoiced in the currency of an EU country or of the trade deal partner only.

The third aspect is well known and frequently dismissed as politically too hard. It is both the inevitable and seemingly unspeakable step of consolidating and expanding the stock of common government-backed assets. The economic and financial logic for a large supply of EU-backed debt securities is now overwhelming: it is key to giving international investors a safe way into the Eurozone at scale, and, as such, a stepping stone to building pan-European capital markets, lowering funding costs for investments in Europe, and redirecting towards such investments the hundreds of billions of net savings Europeans themselves send out of the EU every year. These are all goals EU leaders have adopted at the highest political level.

The political logic, however, remains stuck in suspicions that common borrowing is just a way for rich countries to subsidise poor ones. This is why I have argued for large-scale common borrowing to reinvest in private sector funds, rather than funds passed on to national budgets. But more important than the technical solutions, of which there are many, is the need for statecraft — from Germany above all, as the leader of the debt-sceptic camp — based on the realisation that for the EU to be a great power, it needs to offer other economies a safe place to park their savings rather than look for the world to absorb the savings it does not know how to deploy at home.

Fourth, the EU needs to show the world that it will use its financial power, such as it is today and such as it could become with the steps listed above, in ways that are truly autonomous and at the same time to the world’s benefit.

In part, that would involve deploying tools already available but underused. The EU has hundreds of billions of euros in idle borrowing capacity in its European Stability Mechanism that could be put to good use.

It would, in part, involve throwing its weight around more to stand up against economic coercion from other great powers. Much of the so-called global south and non-European middle powers expected the EU to stand up more firmly against Trump’s trade bullying last year, rather than submitting to an extortionate “deal”. The EU’s great role in trade gives it much greater heft than it seems willing to use.

And trade is not the only place it has geoeconomic leverage; it exists in finance too. Adding to the growing recognition of EU-controlled economic “chokepoints” is an important new report from the Kiel Institute. It highlights how US Treasuries get privileged treatment in EU regulations for European financial institutions that hold them. Tightening this — even treating Treasuries on a par with similar securities — would put significant pressure on US funding costs. This could be seen as a geopolitical lever, but would actually make sense in plain domestic financial terms, as redirected funds would lower financing costs for European financial institutions. Ideally, it would be paired with moves to increase the supply of common EU debt.

Then there is the issue of the immobilised Russian central bank reserves, now about €200bn worth, mostly consisting of a deposit in Euroclear Bank in Belgium. There is a widespread sense in European policymaking circles that making Russia pay with such frozen assets for its illegal war of aggression in Ukraine would undermine the international role of the euro. But this is a misunderstanding. If anything, it is the EU and its member states’ fear of touching these assets that reveals the bloc as not yet the autonomous financial power it needs to be. (Trump’s utter nonchalance with respect to sovereign assets under US control is not an example to follow but an instructive contrast.)

A global power cannot behave as if its own financial security is hostage to what is, at the scale of its economy, a small amount of money. That does not, of course, mean that the EU should disregard protections for investors’ assets. But it means it should be clear that that protection is secured with a minimal level of compliance with global norms and international law. At the same time, the EU’s own financial power should also serve those same norms and rules. In Russia’s case, that could involve transferring the blocked sovereign claims to a new banking entity, isolated (unlike Euroclear) from the broader financial system and designed in time to make good on Russia’s clear obligations to pay compensation.

An institutional apparatus to manage these obligations is already being built in the form of an International Claims Commission. For the EU to support this, including by making available the aggressor’s financial assets, would not undermine its global standing, whether in geopolitical or financial terms. It would enhance both.

Other readables

● It’s 10 years this week since the Brexit referendum. I got my anniversary piece in ahead of time, in a column where I argued rejoining is just a matter of time. But there is plenty of new reading out to mark the event, so here is a selection:

● The FT has a hamper full of articles about Brexit, 10 years on. (My favourite is the draw-your-own-chart game.)

● The Resolution Foundation analyses how Britain lost its trading edge.

● The Centre for European Reform has published an update of its influential measure of the economic price of Brexit. It finds that leaving the EU’s single market has cost the UK economy more than leaving its customs union.

● The UK parliament’s business and trade committee slams the government’s “reset” in a new report on UK-EU relations.

● And with Andy Burnham set to become the UK’s next prime minister without even having to challenge the current one, why not take a look at how the best productivity specialists judge the “Manchester model” of economic growth.

● The EU has implemented 30 per cent of the Draghi report’s recommendations, according to an influential think-tank.