Is a European safe asset the right answer for the EU?

There are evidence suggesting that a European safe asset could contribute to deepening the financial market in Europe as there is a positive correlation between safe assets and private capital investments. However, more supra national EU-debt will not automatically create a safe asset. Public debt of large trustworthy economies is normally seen as a safe asset. Should however, debt become too large, and should investors judge it as unsustainable, there is no safe asset anymore.

Lately, French government bond interest rates have risen as France struggles to agree on a balanced government budget after running government deficits for many years. Having two large economies such as Italy and France with high levels of debt may not seem sustainable to investors and do not bode well for the creation of a European safe asset. Bundling good debt with bad debt was the toxic cocktail that led to the global financial crisis and in the case of joint European supranational debt, one might question how much safety Germany can guarantee?

Looking at the supply of safe assets in Europe there is an abundance of Member States’ government bonds denominated in euro, but those that are considered safe, seem be in short supply. Should Member States achieve better fiscal discipline and reduce debt-levels, a joint borrowing scheme like the one Brunnermerier et. al. (2016) propose, could give the EU benefits. But the current set up of SURE, the Recovery and Resilience Facility as well as the proposal by Blanchard and Ubide (2025) will probably bring the EU economy more disadvantages than advantages.

Debt risks becoming larger if borrowing costs would decrease. There has been a lack of consistent fiscal discipline in many Member States, debt in the euro area reaches far beyond the agreed 60 per cent of GDP as it is.

Finally, can European safe assets help the euro to take the dollar’s place as the world’s reserve currency? The answer is no, as it takes more than having a safe asst to become a reserve currency area, as Christine Lagarde herself points out. EU struggles with persistent low growth, years of underinvestment in defence, over-regulation and fragmented markets. At the same time, the US’s constant and large balance of payment deficit automatically spreads dollars around the globe. In addition, the US is still the largest military force in the world as well as the largest economy. It dominates the financial markets and oil prices are set in dollar. Still, some Asian countries have been able to price oil in their own currency their need to hold US sovereign bonds has decreased so the US position may be weakening.

However, taking over the status of the US dollar means that the EU must change and prove itself in many areas. It must gain investors’ trust and find ways for the euro to be spread around the globe. The US dollar’s global dominance may be declining but creating a joint EU super-sovereign bond is not likely to make the euro global.