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Through the fog that has shrouded global markets during the second coming of US President Donald Trump, a form is starting to take shape. If you squint, you can just about make out an outline of how Europe can mount a challenge to the centrality of the dollar in global finance, and what reform of its disjointed government bond markets might look like.
This will be a long, stuttering, at times exasperating process. It is Europe, after all. But the question of whether to give the euro a glow-up and make it more suitable for global official reserves is over. The answer is yes. Now comes the how.
One possible answer is to do nothing. The Eurozone could use its imperfections to its advantage. Rather than offering one huge unified government bond backed by each member and feeding spending in each state, it could stick to what it already has: a loose-ish collection of national bond markets with different sizes, flavours and externally-assessed measures of their safety. Some big investors like that variety, and it might be possible to sell it as a virtue to the state-backed managers of vast pools of cash around the world.
But “might” is doing some serious heavy lifting there. This view has its merits, but Eurocrats of most flavours, and bankers inside the EU, are generally putting more effort into thinking about how better to join forces and mount a challenge to the significantly bigger, slicker, faster moving market for US government bonds. This is very clearly a live debate.
“We have this permanent discussion about joint borrowing,” said Michael Clauss, German ambassador to the EU, at a Financial Times event in Berlin this month. “There was never a meeting [of government representatives to the EU] that I recall in the last 12 months or so without mentioning either euro bonds or making ideas for joint borrowing,” he added — a nod to how this is not only a response to Trump, but a broader debate about how to fund European defence.
Ultimately, this will be a political decision. But the drumbeat of support for Europe to make its move here is growing louder, including from European Central Bank president Christine Lagarde, who wrote this month on the “global euro” moment. In part, as Lagarde spelled out, that rests on Europe’s already significant role in global trade and on the use of the euro as an invoicing currency — a role it should continue to build out.
This is often overlooked but hugely important, as the dollar’s even bigger function as a global invoicing currency goes hand in hand with its outsized slice of global reserve assets. “It’s not just an administrative decision” to tilt reserve assets away from dollars, said Themos Fiotakis, a currencies analyst at Barclays, in a briefing this week. “It’s not ‘oh I’m mad at President Trump, I’m going to take revenge by buying euros’.” Instead, he said this follows an “ancient recipe” of saving rainy-day funds to provide liquidity to keep trade flowing in a crisis. Logically, then, more trade in euros outside of Europe would feed a stronger case for more euro reserves.
Again, though, we come back to where those reserves would go, and what the dominant euro asset might be. On that question, the ECB’s chief economist Philip Lane this month drew conspicuous attention to a “red bond/blue bond” framework first sketched out as far back as 2010.
This would involve euro member states ringfencing a revenue stream and using it to service common “blue” bonds, the proceeds of which would be used to purchase a chunk of national “red” bonds.
The idea did not get off the ground in 2010, because of lack of political support, and for good reason. Back then, you could drive a bus through the gaps between the borrowing costs of the safer euro members — notably benchmark and bedrock Germany — and those of weaker links such as Italy, to say nothing of states in full-blown solvency crises. Given those spreads, why should Germany sign up to irrationally high costs? It was difficult enough to keep Greece in the Eurozone without adding another layer of likely dispute.
Now, though, spreads have all but vanished. As Lane says, the euro’s “financial architecture” is much more robust, its banking system is better capitalised, a variety of imbalances have been ironed out. That means, he continues, “structural changes in the design of the euro area bond market would foster stronger global demand for euro-denominated safe assets”.
Some bankers sniff that Europe’s banking union is imperfect, its capital markets union is a dud, insolvency laws remain incompatible from one state to the next, and the US just works. All of that is true, but the “blue” bonds idea — trumpeted also by finance heavyweights Olivier Blanchard and Ángel Ubide in a paper for the Peterson Institute — does at least provide the possibility of not allowing the perfect to be the enemy of the good.
Blue bonds may not end up being where this all lands. But one way or another, the timing is right for European politicians to grasp this nettle. It is notable that the discussion has moved on from admiring the problem of Europe punching below its weight, to figuring out how to fix it.
katie.martin@ft.com
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