Can the EU replace US debt as a safe haven?

BarcelonaSince Donald Trump's return to the White House, confidence in the US economy has been shaken. The trade war against its trading partners, plans for massive tax cuts, and inconsistent foreign policy have damaged the US's reputation as a leading economic power. This has been reflected, in part, in a fall in the price of the dollar—the global reserve currency—and, by extension, may affect the role of US Treasury bonds as safe haven assets essential to the functioning of the global economy.

Given this context, can the European Union—or, at least, the countries that share the euro—offer an alternative to a possible decline of the dollar? The answer, as is often the case in these cases, is a resounding and resounding "it depends."

First of all, we need to understand what a bond is and what it does: bonds are debt securities issued by a government, that is, an instrument for citizens or companies to lend money to public administrations in exchange for getting that money back with added interest.

But they're not just for governments to have money available to invest and spend on public services; they're also an essential asset for the global financial system, as they're one of the tools central banks use both to control inflation and to maintain bank liquidity through massive purchases or sales of these securities. Furthermore, they're usually a safe asset, especially the debt of rich countries, which both individual and institutional investors (banks and investment funds) use as a safe haven to ensure that some of their money isn't lost. This is particularly important in the case of US debt, which is the most in-demand in the world.

The fact that the US is the world's largest economy means that many investors trust the solvency of the US government. After all, if the US goes bankrupt and can't pay its debt, the entire global economy would suffer. Therefore, it wouldn't matter where an investor invested their money, because if the US doesn't pay, it's quite likely that the rest of the countries won't either. Precisely because it's the largest and richest economy, the chances of Washington declaring bankruptcy are very small. This explains a substantial part of the demand for US bonds.

The other is the role of the dollar as a global currency. The fact that a large part of the world's commercial and financial transactions are conducted in this currency causes investors, companies, governments, and even individuals to accumulate dollars. Rather than having a handful of bills in a drawer or dead dollars in a checking account, it's more profitable to exchange them for government debt, which pays interest and, like the dollar, is guaranteed to be issued by the U.S. government. This demand is accentuated by the fact that the U.S. is a net importer (buying more abroad than it sells), which further increases the amount of dollars in foreign hands.

The Short-Sized Role of Eurobonds

If demand for dollars were to fall due to uncertainties surrounding the Trump administration, could the EU fill the void? "Global investors are seeking alternatives to the US bond market, which until recently was perceived as deep, liquid, and safe," says an article in the Journal of the American Economic Review. think tank Peterson Institute for International Economics, written by Angel Ubide, economist at the Citadel Fund, and Olivier Blanchard, renowned former chief economist at the International Monetary Fund. "Creating a deep and liquid eurobond market would give investors the alternative safe asset they seek," the article adds.

Until just before the pandemic, the idea of Brussels issuing debt horrified governments in states such as Germany, the Netherlands, Austria, and Finland, which have low debt levels, and they saw it as a way for southern states to take advantage of the opportunity to spend even more at the expense of their taxpayers. Finally, the pandemic highlighted the need to invest in digitalization, reindustrialization, and the green economy. As this was a continent-wide investment program, it was decided to finance it with bonds issued by the EU (first called coronabonds and now Eurobonds), and not with national debt.

According to the European Commission, Brussels has issued a total of €495.39 billion in Eurobonds. The money raised from these bonds has been mainly used to finance the Next Generation investment program, around €301 billion, to which another €72.05 billion has been dedicated to community programs related to Next Generation. In addition, €16.2 billion has been used to finance the aid program for Ukraine.

In total, the EU's accumulated debt amounts to €670.2 billion, most of it in the form of so-called EU bonds (bonds with a maturity of one year or more) and around €29.45 billion in EU bills (bonds with a maturity of less than one year). By 2027, the figure is expected to exceed 700 billion - a portion of the increase in defense spending will be financed with the bonds—, to which must be added another 250 billion from the European Investment Bank, an EU entity but independent of the Commission.

The EU bond issue can be described as a success. It's been four years since the first issue, which was for 17 billion euros and received a demand of 230 billion, so the vast majority of investors interested in acquiring them missed out.

However, all these figures in no way overshadow the United States' influence on international debt markets. According to the Bank for International Settlements (BIS), the total value of US government bonds on the markets was $51.3 trillion (approximately €43.7 trillion) at the end of last year. This means that the volume of debt issued by EU institutions on the markets is 0.15% of US debt.

Alternative proposal

Now, it must be taken into account that while the US is a single country, the EU is a union. sui generis of 27 independent states. And, in that sense, access to debt markets and bond issuance is one of the pillars of any country's economic sovereignty. In fact, handing over to the EU institutions the power to issue debt backed by their own finances was an important step in building the political union project in Europe. However, this capacity did not replace the ability of individual EU states to continue bringing their own debt to market.

Thus, although Eurobond issuances have so far been very small compared to those of the US government, the 27 EU governments have continued to issue their own national bonds, and it is in this area that the EU could grow its own debt market. According to the BIS, the 21 countries that will share the euro in 2026 (Bulgaria will join in January) closed, in 2024, a volume of debt in the markets of 12 trillion dollars, far from the 31 trillion of the US but more than any other country, including China.

The article by Blanchard and Ubide proposes what in financial language is known as a solution Hamiltonian (named after Alexander Hamilton, the first US Treasury Secretary, who had the federal government assume the debt of the states): that the EU assume a portion of its member states' debt as its own. "The solution must be to replace a portion of the national debt with eurobonds," the article states.

If so, the volume of debt and the strength of the European economy could indeed represent an alternative to US debt, but for now the proposal is only a preliminary document, and neither the European Commission nor state governments are discussing it. It remains to be seen whether, as happened with the pandemic, circumstances will force a renewed push for eurobonds.