Europe Can Build Own Treasury Market Amid US Fiscal Crisis

A mother’s wisdom often holds true, as seen in the case of the United States’ fiscal deficits offsetting negative shocks from the global financial crisis and the pandemic. This aggressive approach, combined with an investment in industrial transformation as seen in Joe Biden’s Inflation Reduction Act, is stirring concerns. However, Europe’s fiscal orthodoxy contrasts with America’s approach, resulting in a more restrictive policy and limited public investment expansion to meet stated policy ambitions. This stark difference between EU and US economic performances is not due to structural factors but rather a result of a more expansionary fiscal policy employed by the US.

The Unchecked Deficit and Rising Interest Rates

The US’s neglect to rebuild its fiscal firepower during good times is leading to persistent deficits and the recent sharp rise in interest rates. Post the global financial crisis, the US has consistently failed to meet Europe’s three per cent deficit criterion, with the last three years reflecting crisis-level deficits despite a significant recovery and near-full employment. The interest rates for 10- and 30-year Treasury yields have reached alarming levels of approximately 4.7% and 5.2% respectively. This, coupled with issues surrounding the US policy framework and inflation prospects, is causing concern.

The One Big Beautiful Bill’s permanent massive tax cuts, the costly Iran war, inflationary tariffs, and Donald Trump’s attacks on the Federal Reserve, among other factors, are causing a fundamental lack of confidence in expected real returns, US policy, and consequently, the value of assets in portfolios. This is evident among both domestic actors and international holders of US government bonds, leading to a waning of the dollar privilege that previously enabled the US to run large deficits.

The fallout from the US’s fiscal irresponsibility is set to impact Europe. The US’s fiscal deficit is causing an inflationary pressure, potentially leading to a weakened US import demand and a sharp appreciation of the euro. The consequences of these US decisions, over which Europe has no control, could potentially impact Europe’s fiscally cautious stance. As was the case with the sub-prime crisis, the US may benefit from a boost, leaving Europe to face the repercussions.

A Call to Action for Europe

In view of these developments, it is critical for Europe to take counter-action. The growing pressure on the dollar-centred global financial framework presents an opportunity for Europe to establish a market for EU debt. This will not only ensure that public investment can take place across the EU at low interest rates, even in countries with limited fiscal space but also reduce the risk of national “doom loops” between fiscal authorities and banking systems. Additionally, the creation of a single safe asset would bolster the ECB’s ability to intervene in the bond market when required.

The international context only strengthens the case for the creation of a market for EU debt. The weakening of the dollar system and the resulting nervousness among international investors signal a compelling need for a more dependable option. A market for EU bonds could attract investors looking for stability in an entity known for its solid stance and commitment to upholding international trade norms. This would enable Europe to finance necessary investments more cheaply and potentially reverse the outflow of European savings to the US, which currently stands at around €300 billion a year. Ultimately, it could help transition towards a more multipolar global financial system, integrating countries such as China and India.

If the EU chooses to respond to the US’s fiscal challenges by establishing EU bonds serviced out of its own resources, it could, in the long run, shed its dependence on the US and boost its autonomy on the world stage. A growing, liquid market for EU bonds is an essential pillar for this transition, generating low-cost financial resources to fund the investments required to drive Europe’s economic transformation.