Europe's Existential Crisis/The Dollar Debasement Trade
A proposed new EU defence strategy opens up several new cans of worms. And what the soaring price of gold and Bitcoin says about confidence in the US currency
It is just two months since I wrote this piece on the urgent need for Europeans to confront the danger of Trump 2.0. Since then, the outlook for the continent has only deteriorated. Donald Trump taken a step closer to regaining the US presidency, having now secured the Republican party’s nomination, increasing the risk that Europe may imminently be faced with the loss of the American security umbrella. At the same time, Ukraine’s fortunes have sharply deteriorated. Lacking the weapons it needs to defend itself, let alone drive Russia off its territory, there is now open talk of a Ukrainian defeat. That would only embolden Vladimir Putin to continue his assault on the wider European order. For Europe, this is becoming an existential crisis.
Yet while there has been plenty of lofty rhetoric, there is little sign that Europeans are rising, or are capable of rising, to the challenge of this moment. Instead, Franco-German relations have deteriorated to their lowest point in decades, with open squabbling between French President Emmanuel Macron and Olaf Scholz, the German chancellor, despite a hastily convened summit in Berlin yesterday designed to put on a show of unity. Britain has just cut defence spending to create fiscal space for tax cuts - this when it has just emerged that the Ministry of Defence is facing a £16.9 billion deficit in its 2023-33 equipment budget. Meanwhile, the EU only managed to deliver 30 per cent of the one million shells it had promised to Ukraine by March.
That said, there has been one significant development. Earlier this month, the European Commission set out proposals for a first European Defence Industrial Strategy (EDIS). Its aim is to bolster Europe’s defence sector by investing “more, better, together and European”. This is an industry that has until now resisted EU single market integration, reflecting its close relationship with national governments. This has left it lacking scale, or the capacity to produce weapons quickly and in large quantities. One consequence is that 78 per cent of European defence procurement last year came from outside the EU. The Commission proposals envisage EU member states procuring at least 40 per cent of defence equipment collaboratively and 50 per cent from within the EU by 2030, rising to 60 per cent by 2035.
Nonetheless, one does not have to delve too deeply into the detail of the EDIS proposals to see that it is beset by problems. These include:
Inadequate funding: The current plans include just €1.5 billion of funding, a far cry from the €100 billion that Thierry Breton, the Commissioner responsible for EDIS, had said he wanted. True, this money is only an interim solution until a new seven year EU budget takes effect in 2028. But it is far from clear where a bigger fund will come from. Several member states oppose the obvious answer: a new issues of European bonds. Indeed, the German Constitutional Court has ruled that the common bonds issued to fund the pandemic recovery plan must be a one-off. Without a large fund to incentivise more joint procurement and build up of European stockpiles, it is hard to see how any real progress can be made.
Protectionism: France, in particular, is determined that EDIS should make the EU more self-reliant in defence manufacturing, in line with its vision of European “strategic autonomy”. But why does it matter if arms are imported? Even Russia has been importing vast quantities of weapons from North Korea and Iran to fight the Ukraine war. Other factors are surely more important, including cost, effectiveness and ability to produce at scale. The European Parliament fears that a Buy European policy might invoke US retaliation. Several member states also question the Commission’s plan to exclude Britain, whose large defence industry is already well integrated into the EU market and which is a vital security partner in the challenges facing the continent, treating it as a third country.
Power Grab: EDIS would incentivise governments both to pool procurement and decision-making on exports. The lack of a common approach to exports is often a barrier to common armaments projects. Some may be reluctant to give up what is usually regarded as an important aspect of foreign policy. At the same time, EDIS proposes the creation of European stockpiles, which will help bolster the order flow for European manufacturers, make European products more attractive to foreign buyers and provide a strategic reserve for future crises. But it raises awkward questions as to who would own those stockpiles. Some governments fear that EDIS is a Commission power-grab and are likely to resist any plan that gives Brussels control over exports of weapons.
Subsidies: At the heart of EDIS is a plan to use European funding to subsidise European defence production. But given that Europe’s largest and most competitive defence contractors are based in the EU’s largest member states, this risks being seen as a big transfer of European funding from smaller and poorer states to richer ones. That inevitably raises the usual questions of equity that underlie all European budget negotiations particularly if, for example, the increase in defence spending was to be paid for by a cut in agricultural subsidies at a time when many member states are facing protests by farmers.
The good news is that the Commission is at least forcing European governments to confront these difficult issues. Nonetheless, the reality is that there will be no deal on EDIS until after the European Parliament elections in June and the installation of a new Commission. Even then, there is unlikely to be any significant new money until the next EU budget is agreed in 2027. Any benefits are therefore in the long-term, and too late to be of any assistance to Ukraine. What’s more, EDIS only tackles one element of Europe’s security challenge. It cannot fill the gaping gaps in Nato’s command structures, military preparedness and intelligence gathering that would be left by an American retreat. Nor does it address the deep problems with the EU’s single market which have a direct bearing on Europe’s resilience.
Perhaps the scale of the strategic disaster facing Europe should Ukraine be defeated and Donald Trump be elected will be sufficient to jolt European governments into action, in line with Jean Monnet’s famous prediction that “Europe will be forged in crises”. But that will require a degree of leadership of a kind that Europe currently lacks. The risk is that soaring support for right and left wing populist parties in the June European Parliament elections will further undermine the authority of today’s leaders. But those elections, combined with the looming general election in Britain, are also an opportunity for leaders to confront the populists and build a broad political and public consensus on the need for deeper European cooperation and integration to confront that existential challenge. Let us hope that they seize it.
The Dollar Debasement Trade
A headline in the Financial Times this week proclaimed that “stock markets undergo a risk reset as indices notch new records”. Extraordinary bullishness about the health of the global economy has lifted the prices of almost everything. That includes, oddly, the prices of gold and Bitcoin which are usually held as insurance against financial crises. But despite having little or no intrinsic value and providing no income, which is quite a drawback when interest rates are at a 15 year high, Bitcoin this month hit a record high of $73,000 while gold is £1,696 an ounce, just off its recent all-time high.
What lies behind these rises? According to Michael Hartnett, chief investment strategist at Bank of America, they represent the dollar debasement trade, reflecting investor fears over the long-term prospects for the US currency. He points out that the the US national debt is rising by $1 trillion roughly every 100 days. It took 92 days for it to rise from $32 trillion to $33 trillion, 106 days to rise to $34 trillion and will take 95 days to hit $35 trillion. The US budget deficit (“financing domestic bliss and overseas wars” ) has averaged 9.3 per cent of GDP over the past four years. US public debt is now 124 per cent of GDP, up from 60 per cent a decade ago, excluding vast unfunded liabilities for social security and medicare that are almost three times as large.
Financial Warfare
What’s more, finding investors to buy that extra $1 trillion every 100 days is getting harder. China and countries in the Global South are reducing their holding of dollars, partly in response to America’s weaponisation of the global financial system. At the same time, many countries are actively diversifying away from the dollar for trade. The dollar’s share of global reserves has fallen to 58 per cent, down from 71 per cent in 1999. Meanwhile the use of China’s Renminbi to settle global trade is rising, albeit from a very low base. Beijing is encouraging its trading partners to use RMB and to use of its own settlement system as an alternative to the West’s SWIFT.
True, the decline in the use of the dollar for trade may simply reflect the fact that it is currently much cheaper to borrow in RMB than dollars, as this paper by Neils Graham and Hung Trang of the Atlantic Council think-tank points out. Meanwhile, all the usual reasons for continued dollar supremacy remain: notably the lack of any real alternative, not least given the lack of convertibility of the RMB. Nonetheless, there are two reasons to keep a close eye on the dollar debasement trade.
The first is US politics. Can America get a grip on its budgetary problems? President Joe Biden has put forward a fantasy plan for large increases in public spending funded by tax rises on the better off and companies that has no chance of being implemented unless the Democrats get a clean sweep of the Presidency and Congress. The same is true of the deep spending cuts that the Republicans will insist upon if Trump regains the White House. America has been lurching from one budget crisis to another for years, with the federal government coming frequently within hours of a shutdown as debt ceilings are reached. This dynamic is unlikely to change after the election.
Zero Sum Game
The second is history. Much of the confidence in the dollar’s continued supremacy reflects the fact that is a global public good. But as Harold James, a professor of history at Princeton University, notes in this interesting piece, geopolitical conflicts can often bring a sudden change in thinking as the priority for governments shifts from maintaining global financial stability to how to win a zero sum game.
In the twentieth century, both world wars were preceded by the formation of rival blocs and an increase in targeted financial attacks. As diplomatic tensions escalated, each side tried to undermine the other’s capacities through a financial war of attrition.
In the build up to the First World War, for example, France launched a speculative financial attack on German securities, triggering financial panic. And before the second world war, German economic planners repeatedly used an Amsterdam bank to launch attacks on the French franc, ultimately succeeding in constraining France’s military budget. “This financial mobilization set the trap that closed on France when Nazi Germany invaded in 1940”, says James.
Could something similar happen today? Could we be returning to a world where speculative financial attacks join the arsenal of hybrid warfare? In his bizarre interview with Tucker Carlson last month, Putin drew particular attention to the extent to which the dollar underpins American strength. According to James:
He then sketched a scenario in which the world would turn on the dollar and emasculate an enfeebled America: “But they won’t stop printing. What does the debt of $33 trillion tell us about? It is about the issuance.” Make no mistake, this was a call for an attack on America’s dominant financial position.
Of course Putin issues all sorts of empty threats and there is no reason to believe that there is any imminent danger that others will rally to his financial call to arms. But the broader point is that the dollar based global financial system is a global public good too easily taken for granted, not least by American lawmakers. The risks to its stability, both from fiscal incontinence and financial warfare may be greater than many wish to acknowledge - as the strength of the dollar debasement trade shows.
Woe, woe, and thrice woe!
Vladimir is coming to get us, and they say that he eats babies too.
Our foodbanks are going to be overrun by rampant Russkies.
We need a new kind of leader who can lead the nation in coordinated crying. That Jens Stoltenberg was all talk and no tears!