On 19 January 2021, one day before President Joe Biden’s inauguration, the European Commission published a communication on The European economic and financial system: fostering openness, strength and resilience.
The communication has been interpreted by many as calling for a greater global role for the euro as a reserve asset, eroding the dollar’s position. It could also be read as casting doubt on European reliance on the US and the dollar given the Trump administration’s unilateralist use of financial sanctions. This was neatly captured in the phrase ‘open strategic autonomy’.
The central theme of the communication was that creating a stronger European financial system is a precondition for a strengthened euro reserve role. Brussels is looking to lessen the dollar’s global role as a means to push domestic financial market reform.
The European Commission sets out some well-founded and sensible recommendations.
- The most important call is for progress in building a robust European financial system. While noting Europe’s gains in the banking union and the Single Resolution Fund, the communication reiterates the longstanding need for progress on the Capital Markets Union and the European deposit insurance scheme.
- The Next Generation EU fund and temporary Support to Mitigate Unemployment Risks in an Emergency will provide for issuance of around $1tn in safe euro area assets.
- It calls for a unified European approach to financial sanctions.
However, the communication neglects to acknowledge some key obstacles.
- Progress in building a robust European capital market is clearly lacking, even if the CMU is an important priority. This will require greater harmonisation of national rules. The EDIS has long been debated yet has not materialised. Europe’s large global banks are comparatively weak relative to peers.
- Notwithstanding Next Generation EU/SURE, $1tn in euro area safe assets is only around 6% of European gross domestic product. Sovereign issuance remains overwhelmingly a national activity. Aside from bold actions during crises, key euro area creditors have limited appetite to push forward on risk sharing or fiscal union.
- The European Union is right to express concern about the unilateralist use of financial sanctions in the US. However, doing so the day before Biden’s inauguration was odd, when it seems probable that his administration will aim for greater multilateralism and co-operation.
- There are financial protectionist overtones in suggesting that financial infrastructure should be maintained in the euro area, especially in the wake of the UK’s departure from the EU. Emphasis should be placed on robust cross-border supervision, rather than locational requirements. For example, large-scale clearing of dollar interest rate swaps has long taken place in London without problem.
The European Commission recognises that the dollar’s reserve role is attributable to the size of the US economy and the depth and liquidity of its capital markets. Being a reserve currency entails costs but on balance is beneficial, and the dollar’s role gives the US power over global finance.
Former French president Valéry Giscard d’Estaing first voiced concerns about the dollar’s ‘exorbitant privilege’ in the 1960s. Sixty years later, Europe continues to lament the dollar’s privilege. EU member states have not been willing to develop a large market in European safe bonds, make significant progress on a fiscal union or create a robust European capital market. Europe’s economy is seen as less dynamic than the US economy. Further, when the euro appreciates, concerns are immediately expressed about deflation and export-led growth models.
The US benefits from the dollar’s reserve role. But the US would benefit even more from a world in which major economies run stable policies, boost domestic activity and avoid reliance on external sectors to power growth. Such a world would better distribute global demand, help reduce US habitual trade and current account deficits and could even lessen protectionist pressures in the US. It could also lead to an orderly diminution in the dollar’s global role.
The European Commission’s thinking in the communication is understandable in principle. But it will be difficult to implement given persistent fault lines in the euro area’s monetary union. While a diminished dollar reserve role could be a logical consequence of Brussels’ vision, it remains far from clear that member states are prepared to take the necessary actions.
Watch what member states do, not what Brussels says.
Mark Sobel is US Chairman of OMFIF.