Greenland Gripes

Europe won’t weaponize capital flows

Markets are debating Europe using its large net creditor position vis-à-vis the US to push back against the administration’s Greenland policies. I don’t think that’s a credible threat. The US have an advantage in the weaponization of global finance, not least thanks to the dominant position of the dollar. Europeans are therefore likely to stick to trade measures if they were to retaliate. At the same time, the risks of an outright trade war are now higher than ever because the stakes for Europe are higher than ever. While the Europeans may concede in the end, they are unlikely to go down without a fight this time.

Photo by Gaël Gaborel - OrbisTerrae on Unsplash

That “pop” you heard over the weekend were champagne bottles being opened in the Kremlin. (I’m not sure what Xi was having – rice wine?)

Markets are less pleased, but have so far reacted in an orderly way – although Japan’s bond crash may not be entirely unrelated to the US-Europe frictions. In any case, the developments on Greenland underscore that we are faced with what I’ve called framework uncertainty rather than mere policy uncertainty: it’s not uncertainty within a given framework, but about the framework itself. In this environment, periodic bouts of volatility are the good scenario.

Meanwhile, there is still a possibility that the Greenland situation gets resolved in a non-escalatory way, through some combination of market reaction, US institutional guardrails (namely, Senate Republicans restraining the President; and/or the courts intervening – I’m writing this before any announcement of a SCOTUS ruling on the IIEPA tariffs), and negotiation.

One solution that is conceivable would be for Europe to pay for US military assets to be stationed in Greenland, perhaps by handing over some exploitation rights for natural resources. Another possibility would be some sort of long term “lease” (say, for one hundred years), whereby Denmark and Greenland maintain sovereignty but give the US the right to use Greenland as they see fit.

But the probability of escalation is high, in my view, and that’s what I want to focus on in this post.

If you owe your bank 10 trillion, your bank is in trouble

In particular, there is much discussion in markets about Europe using its sizable holdings of US assets to push back against Pres. Trump on Greenland. Here’s why this is not a credible threat, in my opinion.

Implementation

It’s far from clear how this would be implemented. European claims on the US are overwhelmingly private sector assets (notable exception: Norway’s fund), over which governments have little control.

One option would be to impose capital controls, but these would have to be global, as otherwise European money could easily find its way into US assets after some detour. But global capital controls are a very drastic measure – not to mention that imposing them would contradict Europeans’ cherished principles of rules-based policy and open markets.

Another option would be some kind of regulation, “soft” (moral suasion) or “hard”. The former could be things like, say, leaning on European pension funds (esp. of the wider public sector) to divest from, or stop acquiring further US assets. The “hard” way would be outright regulation for banks, insurance companies, and pension funds regarding their foreign currency exposure. Again, these would be quite drastic measures. What’s more, pension funds have a fiduciary duty towards their clients.

Losses

Word in the markets of a European exit from US assets would impose significant losses on European asset holdings. Europe would be cutting its nose to spite its face.

Retaliation

Europe may be a net creditor is vis-à-vis the US, but US gross holdings of European assets are sizable.

King dollar and the weaponization of global finance

It would be unwise for Europe to generate major ructions in global financial markets, not only because it may suffer significant losses on its assets. Through the dominant position of the US dollar and the control the US exerts over the global financial plumbing (including for example payments services), Europe would be shooting its own foot.

Take one obvious example: a global crisis scenario always comes hand-in-hand with a global dollar shortage. For all the talk in markets about “Sell America”, I wouldn’t bet against the dollar in a crisis scenario. EU and British banks would be particularly affected by such a shortage. There’s only one player that can create dollar liquidity to counteract this shortage – you guessed it: the Fed. A simple majority in both houses of Congress could be enough to compel the Fed not to extend dollar swap lines. Mutually Assured Destruction is not sound policy, especially if escalation dominance rests with the other side.

A more subtle argument would be de-risking. European asset managers may decide themselves to reduce their exposure to the US. If that’s the case, that is likely to be a gradual process and it’s not obvious whether it can be weaponized as a pressure point.

Back against the wall

That doesn’t mean that European leaders will fold without a fight this time. Europe’s main leverage at this point consists in it not having much more to lose.

The risk of a trade/economic war is now greater than ever, because US conduct on Greenland is touching on sacred European principles and constitute a direct provocation.

It made sense for the Europeans not to retaliate against the reciprocal tariffs for two immediate reasons: that a deal would bring less uncertainty for business via an end to trade disputes; and of course some support on Ukraine. The Europeans have gotten neither.

Thus, European leaders may feel that once there’s no more upside from retreat, then they may well stand and fight. They will also realize that “the whole world is watching” and that if once more they fold without resisting, nobody will take Europe seriously ever again – especially those who don’t have its best interests in mind.

Last but not least, President Trump was not popular with the majority of European electorates to begin with, and the latest developments have made that worse. In terms of Europe’s domestic politics, the administration’s actions have galvanized the political center and are probably a disservice to the continent’s MAGA allies on the far right (although unfortunately it may also boost various parties of the far left). In short: there will be more pressure on European governments from domestic public opinion to “stand up” against the American president.