The post Covid “Recovery Plan” is a major card in the EU’s hand.
The use of monetary and financial weapons in political gamesmanship is not new; it has taken various forms over time: from the flows of gold and silver travelling over the Silk Road, to cargos of precious metals filling the Spanish and Portuguese galleons returning from South America or more elaborate measures including blockades, embargoes, exchange controls, currency depreciation, financial manipulations or outright frauds, the acceleration of globalization and the growing interdependence of its actors have made access to financial markets a matter of survival.
After a period of unquestioned domination of Sterling, relying on the vastness of the British Empire, it relinquished its leadership to the $ after WWI which, since then, has continually increased its grip over world financial markets. The $ benefitted from breaking its fixed relationship to gold ($35/oz.) in the early 1970’s, from the introduction of floating exchange rates followed by the fall of the USSR and the progressive integration of the communist world (including China) in the world trading system, confirming its status of “reserve currency” and “transaction currency” of choice.
When the EU designed the €, it created the illusion that it could compete with the $ if it carried out successfully its further integration and built a credible military force capable of underpinning its political ambitions but, bogged down with its own dissensions and internal rivalries, it is China that is emerging today as the challenger to American power and the Renminbi as a potential alternative to the $.
The pandemic has shown the unexpected extent to which members of the WTO had become interdependent, revealing a related unacceptable loss of sovereignty. This has only served to reinforce the domination of the $: aware since the early 1960’s of its “exorbitant privilege (the $ is our currency and your problem), the USAmanaged this quasi monopolistic situation in a relative benign fashion. However, more recently, they have more frequently enforced a ban on accessing dollar denominated markets as part of sanction regimes such as those threatened by Trump against suppliers of North Stream II or imposed by President Biden against Russia. Furthermore, during the 2008 crisis, access to dollars became a key factor in stabilizing financial markets and in allowing foreign banks to fund their $ denominated assets; this led to the creation of a network of currency “swap lines” between Central Banks while simultaneously reinforcing further the power of the almighty FED.
It is with this situation in mind that it becomes necessary to consider how the activation of the post Covid “Recovery Plan” can be best exploited to maximize the EU’s influence in world financial markets, underpin the resilience of the € and consolidate its overall position on the world scene.
The Commission has already communicated several aspects concerning the activation of the program: an overall amount of €750 billion, issued over 5 years with maturities stretching from 2028 to 2058. Marketing should take place either through syndication or by competitive auctions supported by a network of selected “primary dealers”. Subject to the ratification of the Plan by all 27 MS, an issuing schedule starting next summer will be published. These specifications, though useful, leave a number of key unanswered questions that must imperatively be resolved before initiating the process.
First one must have the courage – if not the ambition – to name this program for what it really stands. Failing to do so carries a significant risk of being accused by the Eurosceptics of misleading public opinion and could, in due course, strike a fatal blow to the European construction. By its sheer size, the Recovery Plan is clearly a first step in creating a permanent market for “sovereign” debt instruments which are meant to become one of the main financing tools of the EU. This market has all the hallmarks to become significantly larger so that – though the last securities issued under the Plan will be repaid in 2058 – the outstanding debt of the EU at that time will be a multiple of the initial program.
Indeed, despite the significant increase in the EU’s “own resources” being envisaged and whose avowed purpose is to replace the MS’s direct contributions to cover the debt service of the program, the temptation to finance an ever growing segment of the EU budget through debt issuance will prove irresistible, in particular when it comes to financing whole sectors that are not affordable at national level: research, defense, immigration, environment or unexpected events such as the pandemic, etc.
This development brings with it considerable advantages: it will lower MS’s contributions to the EU, helping to reach the equilibrium of national budgets, a feature indispensable to the necessary solidarity between Members sharing the same currency (like in the USA) and allowing support of individual MS in case of hardship or catastrophe. The ceiling of EU debt issuance will have to be made revisable at regular intervals by a co-decision of the Council (with a qualified majority) and of the European Parliament, subject to the approval of the procedure as part of the next Treaty revision. It goes without saying that it also requires the extension of the Eurozone to all 27 MS.
On another plain, it is highly desirable that EU sovereign debt be conceived as a potential rival to the U.S. Treasury market. By developing the use of the € and providing its users with all necessary tools to manage risks (including derivative instruments) comparable to those available in $, the EU will have made a considerable step towards securing its independence. It would constitute an important contribution to reestablishing a healthy equilibrium in the close and mutually profitable partnership that the EU, its MS and the USA have enjoyed since WWII.
Finally, in the light of the imminence of the program’s launch, it is urgent to consider very carefully the distribution and secondary market trading arrangements as well as the responsibilities of each of the actors including the primary dealers, the traders, the managers of clearing and settlement platforms but also the role of the market supervisory and regulatory organs.
Specifically it will be necessary to regulate the market so that it remains under the prudential supervision of the ECB and other EU regulatory bodies. Considering its foreseeable systemic importance, it is also essential that the market’s physical location remains within the Eurozone. Bilateral agreements can be envisaged to allow the clearing and settlement of “swaps” outside of the Eurozone on the basis of reciprocity and equivalence for contracts for which the counterparty to the one expressed in € is denominated in the currency of the country where the designated clearer is located (the USA only for $/€ and London for £/€ swaps). In a crisis, such arrangements would significantly reduce the systemic risk of € denominated contracts cleared outside of the Eurozone.
In light of the domination by American banks of the global fixed income financial markets which has relied on a deep and liquid domestic market as well as a global coverage of fixed income investors, their participation will be key and desirable in developing the market for EU sovereign debt. It is therefor crucial to agree, prior to the launch of the program, the modalities of keeping the monitoring of transactions within the orbit of EU supervisory and regulatory authorities.
Considerations mentioned herein extend far beyond the scope of the Recovery Program as they clearly raise questions relating to the further integration of the Union; if these are overlooked from the start, the chances of establishing a vibrant market in EU sovereign debt securities will be severely compromised.