Money talks: EU strategic autonomy requires a strong euro

The EU’s recent proposals to strengthen its economic sovereignty and the international role of the euro are a step in the right direction but must be followed up by concerted action from member states to expand the eurozone economy as a whole, and its trading reach. Without greater international use of the euro, the Union’s strategic autonomy will be considerably limited.

The EU recently published plans which argue that an essential component of a geopolitical EU is a stronger currency to rival the many advantages the dollar brings to the US. The proposals come against the background of rapid changes in the international system: the rise of China, the impact of Trump, the COVID-19 pandemic, Brexit, and the EU’s decision to introduce Eurobonds. An additional motive was concern at the long reach of the US Treasury linked to the Trump administration’s extensive use of extraterritorial sanctions. Although the EU expects a smoother ride with Biden in the White House, no one can predict who will succeed him in four years, and whether the US will continue with economic and financial policies and sanctions that damage EU interests.

The proposals are a welcome sign that the EU is moving towards a more coherent approach to external affairs and away from the silo mentality that has hampered EU foreign policy for too long. As the EU recognises, there is no magic bullet, and change will be gradual. The dollar is widely used – because it is widely used.

The historic agreement to introduce Eurobonds as a key element of the EU’s recovery programme is an opportunity to move forward and further encourage the use of the euro in global markets. A stronger euro, however, is dependent on a consensus about deepening the Economic and Monetary Union, notably by completing the banking union and capital markets union. There are also risks as well as opportunities in moving towards a stronger international role for the euro.

The euro and trade policy

The dollar has been the world’s major currency since 1945, offering the US considerable advantages in seigniorage, lower interest rates, and the ability to use its financial muscle for political aims. One of the motives for introducing the euro in 1999 was to provide the EU with a currency that could bring similar advantages to the eurozone. Despite initial design flaws and several major problems – the 2008 global financial crisis, disputes over the Greek bailout, the COVID-19 recovery fund –, the euro retains the confidence of most Europeans and has become the second-most used global currency. According to the International Monetary Fund (IMF), its share of foreign exchange reserves is around 20%, compared to the US’ 60%.

However, in terms of trade, the EU continues to use the dollar more than the euro, even in intra-EU trade. Moreover, there is a feeling that the euro does not adequately match the EU’s status as the world’s largest trading bloc and provider of humanitarian and development assistance.

The linkage between the euro and trade policy was most visible in Washington’s scuppering of the Iran nuclear deal, EU foreign policy’s ‘crown jewel’ of recent years, by threatening sanctions against EU companies which wished to continue trading with Iran in compliance with the agreement. Although the EU eventually established an alternative payments system, INSTEX, few EU companies wished to use it lest it harmed their access to the US market. The US sanctions also impacted the EU-based SWIFT payment messaging system, as well as the Euroclear and Clearstream institutions for settling trades. Moreover, EU banks and companies were affected by US sanctions on Cuba, Venezuela, Syria, China, and Russia.

New proposals

The Commission hopes that increased trading in euros rather than dollars will remove the exchange risk, allow more reliable access to finance, and lower interest rates. Various initiatives are to be launched to increase the share of euro-denominated debt by European and foreign entities. Other proposals touch on the EU’s desire to be more independent of UK financial markets post-Brexit.

One key area will be invoicing in the energy and raw materials sectors. All oil contracts and most commodities (e.g. grains, oilseeds, sugar) are traded in dollars. However, DG Energy figures suggest that more than 60% of natural gas contracts are now traded in euros, and the Commission’s strategy targets hydrogen as a new market where the euro’s role should be developed.

It is the massive €750 billion recovery fund, however, that the EU hopes will lead to a larger international investor exposure, boosting market liquidity and the euro’s attractiveness. There are also expectations of expanding the use of green bonds, which the EU has successfully pioneered in the past 18 months. In addition, there are plans to tighten the policing of foreign takeovers using the EU’s new screening mechanism, and efforts will be made to reform the blocking statute that helps EU companies affected by extraterritorial sanctions.

Challenges

Although the EU is right to chart a course to strengthen economic sovereignty, it faces many hurdles. First, the US financial markets greatly surpass those of the EU, while the world’s largest financial centres (i.e. New York, London, Hong Kong) remain outside of the EU and trade in dollar-denominated assets. Second, there is the perception – partly due to the downgrading of some eurozone economies’ public debt – that the euro is less stable than the dollar. Third, the euro will only become a real global currency when there are investment vehicles which can be traded (e.g. US’ Treasury Bonds). The Recovery Fund is not yet that, and there is strong opposition in some member states to ever allowing such instruments to be created. Additionally, there are no proposals to strengthen the international representation of the eurozone. EU Commissioners and national finance ministers still vie for influence in the IMF and other bodies.

The impact on the European Central Bank must also be considered. Like the US Federal Reserve, it would have to take a more expansive view of its remit and take responsibility for the impact of its decisions on the rest of the world (e.g. swap lines, the impact of monetary policy on the borrowing costs of emerging markets). If the history of the dollar is anything to go by, active, flexible, and imaginative management and monetary and/or financial diplomacy would be necessary. 

Another concern often heard in German business circles, is how a stronger euro would impact the EU’s trading prospects. Some leading economists in the US, such as Larry Summers, argue that the dollar’s international role is more of a burden, with large capital flows strengthening its value and hitting its exports.

China and the US

The EU’s strategy barely mentions China although, according to the IMF, its share of global GDP is close to 20% – four times its weight in 2000 – and it is expected to overtake the US economy by 2028. It also seeks to reduce its dependence on the dollar by trading with neighbours like Russia in renminbi, which it hopes to develop as an international currency. Although these plans have stalled, the sheer size of the Chinese economy and the opening of its markets to foreign investors will impact global financial markets.

Some have criticised the EU for presenting its proposals on the eve of the Biden inauguration. There were similar criticisms regarding the timing of the EU-China investment agreement. While the EU has every right to take its own decisions, it would be prudent to discuss China, global financial and economic issues, and bilateral issues (e.g. aircraft subsidies, tariffs on steel and aluminium) with the new Biden administration. The EU should explain its position on global finance, World Trade Organization reform, and sanctions to the new administration as soon as possible.

No strategic autonomy without a stronger euro

Without greater international use of the euro, the Union’s strategic autonomy will be considerably limited. These proposals to strengthen the EU’s economic sovereignty are timely and must be followed up by concerted action involving all member states. For the foreseeable future, the dollar is likely to remain king, and Europe will likely have to bend to Washington’s will. Nevertheless, the dollar’s hegemony may not last forever, and the rapid development of digital alternatives to cash could be a massive game-changer.

The best way to increase the euro’s influence is to continue to expand the eurozone economy and its trading reach. Increasing its trading clout will allow the EU to at least target the large segment of the world that uses the dollar, even when not trading with the US. Ultimately, the role of the euro will be decided by the markets, and depend on a steady track record of stability coupled with the will of EU member states to deepen further political and economic integration.

Fraser Cameron is a Senior Advisor to the EPC.

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