Commentary on the Communication from the European Commission(COM (2021) 32)
On the eve of President Biden’s inauguration, the Commission published a Communication aiming at strengthening the role of the Union on the world stage by developing a policy of “open strategic autonomy” outlined in its Communication of May 2020. This new Communication centres on the development of the international role of the €, strengthening the EU’s financial market infrastructures, improving the implementation and enforcement of the EU’s sanctions’ regime as well of the unlawful extra-territorial application of unilateral sanctions and other measures by third countries.
As was provocatively suggested in a commentary in the Financial Times of January 21st, the American President will have lost no sleep when informed of these proposals, even if most were aimed at the United States (without ever naming them) and at the exorbitant privileges of the U.S.D.
There is no doubt that the Commission’s analysis lists a series of real problems; however, the 15 proposed key measures, as necessary as they may be, are far from providing an adequate response to the structural weaknesses identified. Once again, as was the case with the proposals to create a “European Capital Markets Union”, the Commission fails to address the preconditions needed to reach its goals, as we will try to demonstrate hereinafter.
- The international role of the €
The aim to develop the international role of the € is not only laudable but also essential to fulfil the EU’s ambition of an autonomous strategy within a multilateral world order. The Communication identifies four dimensions of the €’s role: the financing of trade, its attraction for investors, the infrastructure of € denominated financial markets and instruments as well as its role as a Reserve Currency.
If considerable efforts must be undertaken to develop the use of the € in denominating a maximum of cross border transactions outside the Eurozone (ensuring thereby that they settle automatically within the Union), attracting investors and increasing the €’s share in Central Bank reserves is first and foremost a question of the “trust” operators have in the liquidity and resilience of the market as well as that of citizens and monetary Authorities in the sustainability of the Single currency.
In order to justify such trust, it is of paramount importance to eliminate any lingering doubt concerning the risk of “redenomination” resulting from the reintroduction of national currencies. Great progress has been made since the 2008 financial crisis and a number of proposals contained in the Communication aim at reinforcing it: the completion of the Banking Union, the repatriation of some systemically key financial infrastructures, the creation of commodity markets in € together with their corresponding derivatives, &c.; specifically, the Recovery Plan envisaging the issuance of € 750 billion of debt securities by the EU is conducive to add significantly to the supply and liquidity of € denominated instruments, both in quantitative and qualitative terms. However, as long as a redenomination risk exists, it will act as a drawback to the use of the €.
In addition, developing € denominated instruments involves accepting the responsibility for their regulation and in parallel, reinforcing their corresponding infrastructure, responsibility for their smooth functioning, in particular in times of crisis or tensions. It is, indeed, both the size of the $ market, its robust regulatory framework and the trust foreign operators have in the capacity as well as the political will of American authorities to take their own needs into account, which explains their acceptance of the USD’s exorbitant privileges. In this regard, the Biden-Yellen tandem taking over from Trump-Mnuchin will provide a welcome reassurance for operators. If the EU wishes to compete with the USA, it must aim at matching the latter’s very high standards and dedicate the necessary considerable resources to this endeavour.
However, though the pandemic has unquestionably contributed to demonstrate the added value of the EU, not only in terms of health policy, but also in relation to the coordination of mobility or raising joint financing (strengthening the argument in favour of a deeper Union), it has simultaneously revealed tensions among the 27 which increase its fragility. For instance, the compromises reached over the 2021-27 plurennial budget and the €750 billion Recovery Plan have, once again, underlined the weaknesses stemming from the “unanimity” rule as well as, elsewhere, the squabbling regarding border controls and lately, the controversy concerning the Commission’s role in the supply of vaccines. Sovereigntists and Eurosceptics of every shade are blaming, with unabashed bad faith, each incident which should be laid at the door of a decision making process requiring approval of all MS (in a new and unknown area), pushing their criticisms to the point of glorifying the UK and their Brexit choice. By obfuscating the truth that a free for all would inevitably have led to an unfair distribution of available doses, they create, in these troubled times, the perfect conditions for their noxious nationalistic creed to prevail.
Furthermore, diverging interpretations concerning the governance of the Recovery Plan put into jeopardy its capacity to act as the foundation of a stable financing mechanism for the Union, leading, in case of conflict to a confidence crisis in the currency. For example, within the general (inevitable) trend of rising government borrowings, significant divergences have appeared between the path of Germany’s and France’s sovereign debt; over time the gap will become unsustainable and unacceptable (to the Germans et al.) paralysing the mechanisms of solidarity between the 27 and shaking the trust of both European citizens and foreign investors in the €.
Two priority conditions seem necessary in order to ensure an enduring trust in the Single Currency.: the extension of the Eurozone to the EU 27 on the one hand and a significant increase of the Union’s “own resources” on the other.
The extension of the Eurozone, as foreseen in the Treaty, is necessary in order to put the economic and financial management of the Union on an equal footing with the other currency issuing countries with which the € wishes to be compared and compete. This entails creating a powerful executive authority, speaking with one voice in the name of the EU27, because it is only then that, in coordination with the ECB, the Union could assume the heavy responsibilities (and benefit from the corresponding advantages) that are part and parcel of the management of a universally accepted reserve currency (comparable to the paring of the US Government with the FRB).
The need to increase the EU’s “own resources” aims at making the financing of the EU budget less dependent on the MS and simultaneously giving the underpinning of its currency the largest base possible to bolster its credibility. As an offset, in addition to direct financial support (as provided in the Recovery Plan), the European budget could take over from the national budgets of its members, the financing of a credible joint defence program (another indispensable attribute of trust in a reserve currency), as well as other matters such as the environment, foreign affairs, external border controls and immigration. Thus, the € would reduce its exposure to problems that plague from time to time individual MS, such difficulties avoiding to put into question the stability of the currency. The FX market could then fully play its part in the adjustment mechanism of the external value of the €, restoring to the collective benefit of the MS a tool of which they have been deprived individually and which has imposed a rigid national budgetary framework (Stability Pact, European Semester, &c.) leading to painful – often countercyclical – austerity policies.
As long as the two conditions are not met, any attempt to develop significantly the role of the € in financial markets, as a reserve currency or as a tool to increase the geopolitical clout of the EU are destined to remain in the realm of wishful thinking.
- The Euro as a transaction currency
The increased use of the € as a transaction currency has been correctly identified as a proof of its acceptability and must therefore be a priority. It must aim simultaneously at increasing direct investments, developing € denominated financial instruments as well as its usage in international commercial flows. This leads to two specific remarks:
Firstly, the widening of € denominated Capital Markets has already been addressed by the Commission in the early 2000’ with the Financial Services Action Plan and its European Union of Capital Markets (2015), but, unfortunately with scant success, the City of London (outside the Eurozone) having largely dominated the sector in the European time zone.
Secondly, in the commercial field, the European banking sector remains heavily dependent on its access to dollar funding to finance its considerable USD denominated assets and consequently to the “swap” agreements between the ECB and the FED mentioned in the Communication. To encourage international operators to denominate their operations in €, the ECB will have to offer their respective Central Banks access to swap lines to provide the necessary financing (a partial network is already in existence). One should remember, however, that these swap lines can be cancelled unilaterally (in the same manner as equivalences in financial services). Consequently, in order to reinforce the role of the €, it will be necessary to reduce in parallel the volume of dollar transactions financed in the Eurozone to ensure both the independence and stability of the €.
- The sanctions regime and its extraterritorial application
Any sanctions regime introduced by a given jurisdiction is limited, in principle, in its application to its territory and the persons/entities which carry out activities within its borders. The question of extraterritoriality arises when a jurisdiction wishes to extend unilaterally the application of its legislation beyond these limits.
Let us first note that the mere fact of making use of the currency of the sanction’s initiator is sufficient to consider that the transaction falls within his jurisdiction because it follows that the transaction will automatically settle in its territory; challenging the transgression of sanctions does not, therefore, constitute an abuse of an inexistent extraterritoriality.
On the other hand, if a transaction is executed 100% outside of the said jurisdiction, the foundation for applying sanctions is no longer a matter of law but rather a question of relative power. For instance, if the USA threaten sanctions on entities trading with Iran, the latter must make a pragmatic judgement whether their operations with the USA – over which it has jurisdiction – are a priority or can be sacrificed.
This line of reasoning applies mutatis mutandis to the EU and the USA. The EU must determine whether in order to escape extraterritorial sanctions it is prepared to escalate a trade war and, for instance, be exposed to the cancellation of its $ swap lines (see above) which could give a fatal blow to the €. In reality, neither party has any interest in such a confrontation (like nuclear mutual dissuasion) as it will always result in a lose-lose outcome.
However, as long as the USA yield a considerably larger military and monetary might, the EU should significantly reinforce its relative independence before contemplating a challenge based on a moral (?) or “sovereigntist” (disputable) footing.
The Commission’s Communication identifies a series of useful measures to improve the use of the € with the aim of reinforcing the Union’s capacity to weigh on major geopolitical questions. After the pandemic, this stance should contribute to the emergence of a multilateral world governance rather than being under the rule of an American-Chinese duopoly.
Unfortunately, implementing the proposed measures will fall short of its objective if, first, all doubts as to the sustainability of the € are not removed.
Finally, in spite of the welcome declarations, it would be a serious mistake to rely on the goodwill of the new American administration which, from the first day has insisted on its “buy American” creed; there is no indication that it is ready to abandon the use of its currency as a tool of power in the new geopolitical landscape that is emerging. The promotion of the € is likely to face strong oppositions.
It is high time that the EU 27 Member States come to rely first and foremost on their own efforts in order to provide their citizens the economic social and cultural benefits to which they aspire and ensure their peaceful enjoyment.
Brussels, 27th January, 2021