After difficult negotiations, a European emergency fund was put together to support countries most affected by the containment efforts due to the outbreak of the corona crisis. Prime Minister Mark Rutte was praised in the national press for being so steadfast on insisting stricter rules for money to be handed out: countries using the fund have to implement economic reforms. Besides, an ’emergency brake’ procedure has been included in the treaty: if reforms are inadequate, payments from the fund will stop.
Critics however, label the emergency package as a step towards a transfer union, a mechanism that will permanently channel money from the rich countries in the north to the poorer ones in the south. Moreover, critics think the emergency brake is a sham because this procedure can easily be circumvented. The emergence of a European transfer union will not stop with the funds of this emergency package, simply because new institutions will have to be set up to oversee the distribution of emergency funds, and thus will become part of the European bureaucracy.
Although the emergency package is only a first step towards a permanent transfer union, there is more than meets the eye. The package may also cause geopolitical relations in the world to shift. It can give substance to European geopolitical ambitions. To clarify this, we have to pay attention to the changing financial and political role of the United States in the world.
Undisputed leadership US
The U.S. has been the undisputed leader of the Western world since the Second World War. Globalization and the rise of emerging markets since the 1980’s have naturally reduced the relative size of the US economy. However, its leading role remained undisputed. As a result, global financial markets have been centered around the U.S. dollar and the U.S. government bond.
In an earlier article I wrote that government bonds have gained an increasingly important role in the global banking and financial system in recent years. They are used as collateral in financial transactions and credit creation. The construction resembles a pawn shop: you bring valuables and get cash in return. At a later stage, you return the cash and your assets are returned. The assets in greatest demand are the most secure and liquid government bonds: US Treasuries.
Due to the central role of government bonds, financial markets expanded on an unprecedented scale. The global credit economy financed globalization. The amount of debt owed by governments, companies and private individuals has risen sharply in recent decades due to the ease with which loans can be taken out – even after the 2008 debt crisis and the current corona crisis. Apart from this build-up of debt, there are two important consequences.
Firstly, the financial system is becoming inherently unstable. The monetary and financial system appears to be more of a ‘work in progress’ than one of insight and control. In a remarkably frank lecture at the time, ECB Vice-President Vítor Constâncio stated that the international monetary and financial system is prone to crises that cannot be prevented and can only be stabilized afterwards. Governments are then forced to prop up things with taxpayers’ money. To put it mildly, this is not a satisfactory observation.
Secondly, the fate of governments and financial markets is being intertwined. The value of government bonds must remain stable at all times. Price volatility or a sudden drop in the value of government bonds can cause great panic on financial markets, because they can no longer be used as pristine collateral. Central banks of course are trying to stabilize government bonds through their quantitative easing programs. This is the financial side of government bonds.
US leadership not self-evident
However, the political side of government bond markets – the trust one has in the political leadership of a country – cannot be influenced by central banks. And this is exactly where things get problematic. Financially as well as politically, the undisputed leadership of the US is no longer self-evident.
Since the financial crisis of 2008, dissatisfaction with the financial leadership of the US has increased. I already wrote about China’s criticism of the international role of the dollar. They see it as the direct cause of the financial crisis. Moreover, the Americans are increasingly using the dollar as a geopolitical weapon. They are for example trying to bring Iran to its knees by limiting its access to the dollar system.
This subject came into the public domain during a public session in the American Congress on the libra, the digital currency of Facebook. One congressman stated that the international role of the dollar enables the US government to get other countries in line without using military power. Threats to the dollar make the U.S. very nervous, the congressman said. Facebook’s CEO Mark Zuckerberg had to severely curtail Facebook’s digital monetary ambitions. Dissatisfaction with the international role of the dollar is now a widely shared sentiment. It is an important driving force behind countries’ attempts to evade its role.
This movement away from the US dollar as reserve currency gained political momentum with the presidential elections won by Donald Trump in 2016. With his nationalist and isolationist agenda, Trump did everything he could to alienate his European allies. His stance has also spoiled domestic political relations. Every statement or decision made by Trump is disputed both in mainstream media and by the Democrats.
In the meantime, there has been a political riot over postal voting during the upcoming presidential elections. Because of Corona, Americans are encouraged to vote by mail. However, Trump is not happy with this and points to the vulnerability to fraud and logistical problems at the postal services. The elections could end in stalemate if the result is not recognized by one of either parties. The already present social unrest could then turn into riots and possibly even a civil war between supporters of Democrats and Trump Republicans.This can result in so-called fiscal instability: questioning the legitimacy of the government and its abilityof collecting taxes. It is the biggest nightmare for central banks and financial markets. It can discredit US government bonds as being inherintly safe. This poses a major threat to the stability of the global financial system, because US government bonds still play a central and dominant role in it.
The geopolitics of the European emergency fund
And now back to the European emergency fund. By zooming in on political negotiations among European leaders, a crucial geopolitical element can easily be overlooked. Of course, it’s also about transfers of funds to weaker member states. More importantly however, it is a monetary and financial framework that is being set up to achieve a European political union with global power.
With the introduction of the emergency fund, politics and financial markets are closely working together. This is the first time that the European Commission (EC) will enter the capital market on a large scale on behalf of the member states. With the sum of €750 billion to be raised, the EC immediately becomes the fourth largest player in the European capital market. The loans will be guaranteed by all member states, which means that they are in fact Eurobonds.
Eurobonds are an alternative to US government bonds on the financial markets. This also explains why the ECB and the EC are so strongly in favor of them. Although the fund has not yet been set up, financial markets have reacted positively. Since then, the euro has risen sharply against the dollar. Former ECB President Mario Draghi even went a step further in his first speech as former central banker by advocating a European Finance Minister. Self-confidence is visibly increasing.
The combination of global dissatisfaction with the role of the dollar, looming American political instability and the introduction of Eurobonds could lead to a shift in global geopolitical relations. It could give wings to European ambitions.