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A currency lesson in soft power

by Stewart Fleming | 26.06.2017

In October 2011, the 92 year old, wheelchair bound, former West German Chancellor Helmut Schmidt, in a speech in Frankfurt’s Alte Oper, denounced the “dramatic failure” of the assembled ruling elite of Europe to contain the Eurozone debt crisis.

Individually, Schmidt said, the nations of Europe were becoming too small to cope with the geopolitical challenges they faced. Even grouped together, by mid-century they would account for only 7% of the world’s population instead of the 20% of most of the previous 200 years.

Thus it was that on Friday 23rd June the European Central Bank quietly took another step towards the deeper EU integration needed to fulfil Schmidt’s clarion call for Europe to lay firmer foundations to underpin its influence in global affairs.

It announced that it was seeking a “significantly enhanced role for (EU) central banks of issue in the supervisory system of central counterparties (CCPs), in particular with regard to the recognition and supervision of systemically important third country CCPs (Infacts italics) clearing significant amounts of euro-denominated transactions.”

With this statement the ECB put on parade an Exocet missile trained directly at the City of London, its hugely profitable, $573 billion-plus in daily trading of euro denominated over-the-counter financial derivatives, and, notably, one of the “red lines” of British Prime Minister Theresa May’s Brexit negotiating strategy.

The regulation, supervision and judicial oversight by EU entities [InFacts emphasis], including the European Court of Justice, of giant, euro-focused, systemically important CCPs was, the ECB statement implied, a “red line” for the EU.

Post-Brexit, no country in the world will have a more “systemically important third country CCP” than Britain, namely the London Stock Exchange’s LCH Clearnet subsidiary. So, according to the ECB statement, it will have to be overseen by the relevant EU authorities, not primarily, as now, by the Bank of England.

Nobody should be the least bit surprised by this ECB/European Commission initiative. After all, having the capacity to exercise control over its currency is perhaps the most powerful practical demonstration of sovereignty a global power (and in trade terms the EU is the world’s leading global power) has at its disposal short of all-out war.

American institutions insist on regulatory and judicial rights over US$ trading entities in London and elsewhere, providing also the last-resort dollar lending required to back them in emergencies. Moreover, experience has shown it is far easier, politically and practically, to impose financial sanctions on states like Russia, Libya, Iraq or Iran than to bomb them, and control over major entities using the US$ is essential for that.

Washington has long jealously guarded this power. China has more than 30 currency-swap agreements with other nations. Significantly, of the advanced economies of the world, including the UK and the Eurozone, only the United States has not agreed such an accord with China.

For the EU, as a polity which has (deliberately) constrained its military capacities and ambitions, “soft power” of the sort represented by control over its global reserve currency is even more important.

So, like the US and China, the Eurozone wants to be able to exercise sovereignty over the euro and euro-denominated financial markets and so euro- denominated financial instruments.

If the EU does not do this it risks leaving the world’s financial system in the political grip of just the US and China, which, to expand its geo-political influence, is taking huge financial risks in its efforts to internationalise its currency, the renminbi. When the ECB says it has a red line over euro-denominated trading, red really does mean red.

In a column in the Financial Times on 23rd June John Redwood MP, whether out of ignorance or duplicity, sought to deny this threat to London’s financial markets, arguing, inter alia, that, if no deal is reached with the EU, the UK would be just fine trading under World Trade Organisation rules. This arch-Brexiter failed to point out that these rules simply do not cover the City’s financial sector trade.

He also insisted, “There is “no ‘cliff edge’ ahead.” As someone who, in a regular FT column, purports to offer investment advice, he must surely know that the City of London’s quasi-official International Regulatory Strategy Group, earlier this year, produced a report warning specifically of a potential financial crisis because of a financial sector regulatory cliff for London based CCPs if we crash out of the EU into WTO rules.

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Edited by Bill Emmott