US President Donald Trump’s toxic tariff war is not only threatening the global trading system, but also undermining trust in US government bonds and the US dollar. That should alarm everyone, because the global financial system rests on the premise that US Treasury bonds are the safest assets, but investors’ desperate search for alternative safe assets has also given the EU an unprecedented opportunity. In addition to satisfying growing investor demand, a large issuance of common EU bonds would strengthen Europe’s economy, security and policymaking autonomy.
The US dollar — particularly long-term bonds issued by the US government — has long been the ultimate safe haven. Even when global turmoil originated in the US, as was true of the 2008 financial crisis, investors have sought refuge in US Treasuries, but everything changed earlier this month.
Amid the market mayhem unleashed by US tariffs, investors not only dumped US stocks, but also ditched US Treasuries and the US dollar, buying gold, Swiss francs and euros instead. Beyond triggering an economic crisis, Trump’s wildly destructive policies are causing a crisis of confidence in the US itself. While Trump’s partial tariff pause on April 9 stopped the immediate bond-market rout, the situation remains volatile. Once trust erodes, it is not easily regained — especially when there is massive uncertainty about what outrageous blunder Trump would commit next.
The US Treasury market is massive, at US$28.6 trillion, which means that even a small desire for diversification can create huge demand for euro-denominated safe assets. The second week of this month witnessed the largest sell-off of US Treasuries relative to German government bonds since at least the 1980s. Even Italian government bonds, normally seen as a risky bet, have rallied. Investors’ appetite for an increased issuance of EU bonds, which typically boast a AAA credit rating, would almost certainly be high.
The EU has already issued about 1.3 trillion euros (US$1.5 trillion) in common debt. About 620 billion euros of outstanding EU bonds were issued to fund COVID-19 recovery programs; the European Investment Bank had 420 billion euros of bonds outstanding last year; and the European Stability Mechanism, the EU’s crisis-lending arm, had an additional 280 billion euros outstanding (in combination with its predecessor).
However, the stock of EU debt remains tiny compared to the US Treasury market, and the flow of new bond issuance is relatively low and irregular. Pandemic-related collective EU borrowing was meant to be a one-off program, and the European Commission’s new 150 billion euros facility to lend to EU governments for joint defense procurement is likewise time-limited.
Therefore, there is a compelling case for capitalizing on this opportunity to issue many more common bonds and to roll over existing EU debt as it matures. Doing so would bolster the euro’s international role, boost the EU economy and help finance a much-needed increase in Europe’s defense spending.
European leaders have long resented the “exorbitant privilege” that the US dollar confers on the US in the global financial system. The fact that US Treasuries have been the premier safe asset for both official-sector reserves and private-sector portfolios has lowered the US government’s borrowing costs and therefore the interest rates paid by riskier US borrowers, too. It has also given US policymakers exceptional freedom of action, not least during crises, when everyone else typically wants US dollars. Although the euro is a long way from displacing the greenback, it has the potential to be a more important reserve currency and safe-haven asset.
As a geopolitical matter, EU leaders have already endorsed the idea that the euro should play a more important international role. This goal has become urgent now that Trump is wrecking the global order and threatening to use Europe’s US dollar dependence against it.
As an economic matter, issuing EU bonds would help Europe’s economy in the face of US tariffs and Trump-induced, investment-chilling uncertainty. Since EU exports to the US are poised to shrink, fiscal stimulus might be needed to foster alternative sources of demand.
As a security matter, joint EU borrowing would enable Europe to raise hundreds of billions of euros more for its own defense and that of Ukraine, and in a way that does not burden stretched national public finances or require unpopular tax hikes or spending cuts. While Germany has ample borrowing power to increase its defense spending, France, the EU’s most important military power, does not.
As a financial matter, a greater issuance of EU bonds would be helpful for eurozone banks whose holdings of domestic government bonds otherwise tie their fate to that of the government that backstops them. This dynamic was the source of the “doom loop” that drove so much of the 2010-2012 eurozone crisis.
The main objection to issuing common EU debt is, of course, political. Frugal northern European governments have traditionally not wanted to bankroll what they view as southern European profligacy, but Germany and other fiscally conservative governments are now much more open to common EU borrowing, owing to their pressing need to rearm (Berlin is much closer to the Russian border than Rome, Madrid or Lisbon).
Perhaps most importantly, a bold move to issue common bonds would give the EU greater agency. Instead of merely reacting to Trump’s every betrayal and flip-flop, Europeans would be taking control over their own destiny. If not now, when?
Philippe Legrain, a former economic adviser to a president of the European Commission, is visiting senior fellow at the London School of Economics and Political Science’s European Institute and the author of Them and Us: How Immigrants and Locals Can Thrive Together.
Copyright: Project Syndicate
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