ECB drafts strategy to leverage US instability and boost euro global usage

The European Central Bank (ECB) is preparing a plan to increase the use of the euro worldwide, hoping to turn the world’s shaken confidence in the political and financial leadership of the US to Europe’s advantage.

Liquidity lines—agreements to provide short-term loans to other central banks—have long been a standard part of the crisis-fighting toolkit for central banks, but the ECB is now considering repurposing them to advance Europe’s political objectives.

According to POLITICO, one of the plan’s goals is to absorb shocks that would arise if the US, which has underpinned the global financial system with the dollar for decades, suddenly decided to stop doing so or attached unacceptable conditions to its support.

The other objective is to support its foreign trade more actively and ultimately secure some of the advantages the US has historically enjoyed from controlling the world’s reserve currency.

Francesco Papadia, a senior fellow at Bruegel and former Director General for Market Operations at the ECB, stated that such efforts are logical and reflect the growing inclination of European officials to see the euro used more widely across the globe.

Central banks typically use two types of facilities to lend to one another: swapping one currency for another (swap lines) or providing funds against collateral denominated in the lender’s currency (repo lines).

The ECB currently maintains unlimited swap lines with the Fed, the Bank of Canada, the Bank of England, the Swiss National Bank, and the Bank of Japan, while maintaining limited lines with the central banks of Denmark and Sweden.

It also operates a facility with the People’s Bank of China that is limited in both volume and duration.

Other central banks seeking euro liquidity must rely on repo lines known as EUREP. Under these lines, they can borrow limited amounts of euros for a limited time against high-quality euro-denominated collateral.

Currently, only Hungary, Romania, Albania, Andorra, San Marino, North Macedonia, Montenegro, and Kosovo possess such lines.

However, these active lines have not been utilized since January 2, 2024, and even at the height of the Covid crisis, their usage peaked at only 3.6 billion euros.

For the Eurozone’s international partners, knowing they can access the euro during stressful times is valuable in itself and helps prevent self-fulfilling fears regarding financial instability.

However, some argue that if structured generously enough, these facilities could also reduce concerns regarding exchange rate fluctuations or liquidity shortages.

According to POLITICO, such details might sound “academic,” but the availability of liquidity lines creates real impacts on the business world: A Romanian car manufacturer whose bank struggles to procure euros might fail to pay a supplier in Germany, causing production disruptions and increased costs.

One of the ECB’s rate-setters explained, “Knowing that foreign commercial banks can borrow in euros and have access to euro liquidity [as a backstop] encourages the use of the euro.”

This source added, “Liquidity lines, especially EUREP, must be flexible, simple, and easy to activate.”

One option could be to expand them to more countries. Another would be to make EUREP a permanent facility, thereby eliminating doubts about whether euro access will be provided and under what conditions.

Papadia added that the ECB could facilitate access to EUREP by lowering the cost, increasing existing volumes, or extending the duration of use.

In a recent speech, François Villeroy de Galhau, Governor of the Bank of France, suggested that Europe could learn at least one lesson from China, noting that the Eurosystem could “make euro invoicing more attractive” by expanding the provision of euro liquidity lines.

China has established approximately 40 swap lines with trading partners worldwide, specifically to support its developing foreign trade with poorer and more volatile countries.

In contrast, according to Papadia, the ECB—historically a prudent institution—”does not market the euro to the extent that China markets the renminbi.”

Another policymaker told POLITICO that while there is a broad consensus on making liquidity lines more widespread, the Governing Council has not yet clarified the details.

Martin Kocher, Governor of the Austrian Central Bank, stated in a recent interview with POLITICO that a “deeper discussion” had not taken place within the Council, adding that he saw no reason to actively promote euro liquidity lines.

“I am not arguing that you need to stimulate or create demand. On the contrary, if there is demand, we must be prepared for it,” Kocher said, acknowledging that “preparedness is very important.”

Kocher admitted that inconsistent policies from the US could force the euro to “take on a stronger role internationally” both as a reserve currency and in transactions.

According to a Reuters report earlier this month, similar concerns among central banks worldwide have sparked a discussion about creating an alternative to the Fed’s financial support by pooling their own dollar reserves.

However, swap lines, in particular, are not risk-free. “The main risk is that the country uses the swap and then cannot repay the euros drawn; and then you are left with a currency you don’t know what to do with,” said Papadia.

Brad Setser of the Council on Foreign Relations (CFR) wrote in a blog post, “The US doesn’t really want Argentina’s currency. It expects repayment in dollars, so if the swap is never unwound and the US Treasury is left with a pile of pesos, that is a major failure.”

Another central bank official said this line of thinking would lead the ECB to focus on reforming EUREP lines, which are always its preferred tool.

But the problem with this is that EUREP usage may be limited due to a lack of safe euro-denominated assets that can be used as collateral.

Papadia noted that the Fed’s network of liquidity lines works because “the Fed has the US Treasury Department as a sort of partner to provide these swaps.” Unless Europe can create a common debt instrument, a natural limit may be placed on such lines.

“On the other hand, liquidity lines can be used to advance your goals if you already have power, but they cannot create that power,” POLITICO concludes, quoting Gianluca Benigno, an economics professor at the University of Lausanne:

“He argued that for this, Europe first needs a clear political vision regarding its role in the global economy, a Capital Markets Union, and the creation of a common European safe asset. These are issues that only politicians can address.”