The EU’s Reparations Loan Is Risky. Here's An Alternative.

On December 18th, the day I am nervously looking forward to, the European Council in Brussels will make a decision either too prudent or too fatal. Europe has now reached a stage where it needs only one last push to deter Russian aggression. The push however, is not anymore affordable. That is why you and I have recently heard too much about what Brussels calls “reparations loan” which I must admit I hope it be not implemented. The EU is short of Ukraine’s new budget requirements to fund the war expenses and the old cash management technique of immobilised Russian assets is not hereafter responsive. There is still, in my opinion, a chance Europe could pull a fast one and survive this stage, but the main issue is that although minimised, it comes with its own tangible costs. To these we now turn.

Long before any full-invasion war was about to break out, the Central Bank of Russia (CBR), as all central banks do, had bought government bonds of various European nations, securities, currencies and other assets in Europe and deposited them into the largest most reliable Central Securities Depository (CSD) in Europe, Euroclear, in Brussels. Comes the cursed 24th of February 2022, and within hours of the bombardment of Donetsk and Luhansk, Euroclear and few other banks receive the legal permission to immobilise all Russian assets of about 210 billion Euros previously deposited as a means of sanctioning and punishing Russia. Days go by and Ukraine is under serious threat, as Russian troops are reaching Kyiv. Ukraine needed funding. It emanates from EU members that we could financially support Ukraine by using these assets, without any legally unallowed confiscation. Russian-owned bonds and securities receive interests at maturity. Once matured, the interest or in other words “coupons” have to be paid to their owner, CBR. As the EU had sanctioned any monetary exchange with Russia, these coupons stayed idle and unused in Euroclear’s account. To efficiently use these coupons without intervening in the ownership of them, EU moved these assets to the European Central Bank (ECB) and other major central banks, in an attempt to earn interest on them while not using the coupons themselves. It must be heeded here that, as observed, the coupon is indeed used but in the form of an overnight loan or a call money loan in which the money is repaid to the bank shortly and on demand. Therefore, effectively, the EU is using Russia’s principal money but in very short intervals and in a large pool of other assets where no one can, as an outsider, know if the lent money somewhere is of that coupon set. Afterwards, the interest earned on the mentioned coupons will be the EU’s income. This is, of course, of unending controversy between lawyers but from an economic standpoint, perhaps we could state this as true. The interest earned, then, will be used by the EU to fund the Ukraine Facility Plan and the Macro Financial Assistance (MFA) which by now has amounted to 43 billion Euros.

The funding of these programmes as a facilitator for Ukrainian army is in the form of a collateralised loan to reduce the risk of default once maturation is due. Interestingly, in this case, the collateral taker – Ukraine – is not obliged to pay the collateral provider – the EU – in case it defaults years later. This means that if Ukraine cannot repay the loan provided by Europe by say 2058, the EU will itself secure its collateral by taking the future stream of interests on Russian coupons as repayment. Indeed, the provider and taker are the same in the scheme.

One indispensable issue that arises then is that if the war ends, as we all hope, the EU’s collateral loses value in case Ukraine cannot repay its loans. This is because the frozen Russian assets will be mobilised again and thus no future stream of interests can be expected. This is especially dangerous to the global financial system as the cross-border lending might be highly discouraged, the potential global money supply not backed by gold reserves could increase and there might be negative impacts on globalisation. These in turn will reduce the credit per money, meaning that the money in your and my hands could be practically worth less than it did. This will also further the chances of a global financial crisis. The reader might rightly criticise my overly speculative analysis here and I would agree that this chain of events may not occur. However, given the exceptionally large amounts that are dealt with, all in two or three digit billion figures, the concern can be relevant.

Turning to the current state of budget inadequacy, there is, as referred to in my opining lines, a slight chance Europe could still fund Ukraine for its new needs to fight the war. My suggestion t ies back to the similar decisions made by Salmon P. Chase in the US civil war back in the 19th century. It requires the EU to legally allow this, but from an economic view, the ECB can take various loans from, let us say American multinational banks, and buy war goods for Ukraine through paying the defence companies with these loans. The war goods can be transported to Ukraine and assist in the frontline. At the same time, the ECB must take distinctive loans from totally different banks and pay the previous American loans back using these new loans. Simultaneously again, it should invest some of those new loans taken in the most productive highest yielding industries and pay for its new liabilities which include new interests as well. This is, with no doubt, very risky and will inevitably cause inflation in Europe and elsewhere. For this to be achieved, the G7 and the ECB must also work interdependently in war financing which is abandoned at the time of writing. However, as I have read through other suggestions, and of course have not seen one that is flawless, I imagine this can be at least a better alternative to what Mr. De Wever and his allies might be forced to accept, that is the idea of “reparations loan” which effectively breaches the law as it will use Russian assets, and not coupons or their interests, as direct collateral for the funding of Ukraine. Regardless of who is the oppressor, this is not in any way imaginable the right decision.

To get this article to its close, it must not be forgotten that every decision comes with its costs. This is, indeed, the subject matter of economics. This, that scarcity leads to trade-offs and once the best alternative is gone, then it is gone. Europe must choose. It can choose between inflation, breach of international law, financial crisis or the third world war. Not the best menu, one might argue. After all, wars have consequences.