Shorting America: Europe’s financial leverage over the United States

• Europe holds financial leverage: It owns $9.6 trillion in U.S. assets, roughly 1.5 times the $6.4 trillion the U.S. holds in European assets; this asymmetry constitutes financial leverage that can be activated through existing regulatory instruments, should the occasion arise.

• Pulling the lever via regulation: Removing the zero risk-weight privilege on U.S. Treasuries under Solvency II and the Capital Requirements Regulation would raise the capital cost of holding U.S. government debt across European insurers, banks, and pension funds. This privilege is increasingly unjustified, given U. S. debt-to-GDP above 120%andaprior sovereign downgrade.

• The impact is substantial: Conservative estimates imply a $200 billion in Treasury demand withdrawn over a decade, roughly a quarter of QT1 or a third of QE2. Expected yield effect of 11–14 basis points translates into $33–42 billion per year in added U.S. fiscal cost. • The policy is self-reinforcing: Reallocating insurer capital toward European sovereign and bank bonds improves European banks' funding structures, reducing their dollar dependence and relaxing the very constraint that might otherwise deter participation in Treasury divestment.

• The transition is manageable: Partial hedging of European dollar positions acts as a shock absorber, allowing dollar depreciation and yield increases to materialize gradually rather than disruptively, while replacement flows from yield-seeking investors moderate but do not eliminate the structural shift in demand.

Kiel Institute Expert