Europe’s financial leverage over the United States
The United States has recently used various instruments of pressure—tariffs, military force—to advance its geopolitical aims. In Europe, the question of how to respond is increasingly on the table.
The new Kiel Report “Shorting America: Europe’s financial leverage over the United States” shows that Europe can make greater use of the financial asymmetry between the two economic regions, by adapting prudential regulation it already controls. The authors frame this as a last-resort lever intended to inform discussions of European strategic autonomy and stress that correcting the underlying regulatory distortion is sound prudential policy, irrespective of the geopolitical context.
Europe holds USD 9.6 trillion in US assets—about 1.5 times the USD 6.4 trillion the US holds in Europe. This asymmetry gives Europe genuine financial leverage. Activating it would mean removing regulatory privileges that US government debt currently enjoys in Europe. “Right now, US Treasuries get an unconditional exemption—more favorable than their own credit metrics would warrant; under the proposed rules, they would simply be treated according to those metrics,” argues Farzad Saidi, Fellow at the Kiel Institute for the World Economy.
The authors examine removing the zero-risk-weight privilege accorded to US Treasuries under two European frameworks: the spread-risk charge under Solvency II (which governs insurers) and the risk weight under the Capital Requirements Regulation (CRR) (which governs banks). “Given a US debt-to-GDP ratio above 120 percent and a prior sovereign downgrade, this zero-risk-weight privilege is hard to justify on prudential grounds alone,” says Saidi.
The impact would be non-negligible. Across European insurers, banks, and pension funds, the authors estimate that removing the privilege would withdraw on the order of USD 200 billion in demand for US Treasuries over a decade, an amount the size of roughly a quarter of the Federal Reserve’s first round of quantitative tightening. The resulting rise in US yields would add an estimated USD 33–42 billion per year to US federal borrowing costs, equivalent to between one-fifth and one-quarter of the current budget of the US Department of the Army. The same shift could also reallocate capital toward European sovereign and bank bonds, improving European banks’ funding structures and reducing their dependence on dollar funding.
The effects on financial markets would be manageable. Because a large share of European dollar holdings is hedged, the unwinding of those hedges generates partially offsetting flows, allowing any dollar depreciation and rise in yields to materialize gradually rather than abruptly. Exchange-rate developments would nonetheless warrant close monitoring.
