Europe is about to make its biggest strategic mistake

This week presidents Donald Trump and Vladimir Putin “negotiated” the future of Ukraine over the heads of Ukraine and the rest of Europe. Also this week, the European Commission published wide-ranging proposals to boost Europe’s military readiness ahead of a summit where EU leaders will discuss defence and Ukraine.

So this feels like one of those weeks Lenin mentioned when “decades happen”, and choices are made — or left unmade — that may determine Europe’s future for a long time to come. Yet, incredibly, Europe is neglecting the most powerful tools it has to change both the Russian and the US calculus and force a place at the table for itself. Those are its economic sanctions and, above all, the Russian foreign exchange reserves immobilised in the EU.

Europe may be militarily weaker than the US. But in one sphere of power, the EU is the world’s single superpower. Of the roughly $300bn or so the Central Bank of Russia held in western countries when Putin launched his full-scale aggression, more than two-thirds is blocked under EU sanctions. The bulk of this — €183bn on the last public information — consists of a bank deposit in Euroclear, the Belgian bank and securities depository.

This is a lot of money — as much or more than all the western aid to Ukraine to date. What happens to it could decisively tilt the balance between Moscow and Kyiv — on the battlefield or at the negotiation table. Returning it to Russia would give a huge lifeline to an economy that is maxing out its capacity to fuel the war and unable to import more resources. It would also destroy an opportunity to secure Ukraine’s resources for years to come and boost its ability to say “no” to a Trump surrender deal.

Indeed, it’s even worse than that: the blocked foreign reserves are the only reliable source out of which to settle Russia’s indisputable debt for the damage it has wrought in Ukraine (the World Bank’s latest estimate is at $523bn). If they go back to Russia, who will believe that the Kremlin will be forced to pay compensation in a Trump-backed peace agreement? My conversations with senior European policymakers even make me worry that when such a deal materialises, Europe will not push back against insufficient reparations, and that this is one reason for the unwillingness to transfer the assets to Ukraine now.

In July, the EU sanctions that include the block on Moscow’s access to its reserves come up for their regular six-monthly renewal. Since the vote has to be unanimous, Russia-friendly EU member states have an opportunity to end the whole sanctions regime overnight; during past rollover decisions, Hungary had let things drag out until the last minute to extract the maximum concessions for itself. Its incentive to finally pull the plug is increasing with the US changing sides in Russia’s war against Ukraine — indeed Budapest is saying this out loud. If Washington unilaterally lifts sanctions and declares them an obstacle to peace, it is hard to see unanimity for keeping them in the EU.

The moment sanctions lapse, Moscow will withdraw its money and there will be nothing Euroclear can do but pay out. So on the current policy course, hundreds of billions will be sent back to Russia by this summer. Europe’s decision — or non-decision — is what will make Russia victorious.

This raises two important related observations. One is that there are only two possible resolutions of the current block on the CBR’s access to its assets. One is that the money returns to Russia, which is what will happen without some serious policy change. The other is that it is transferred to Ukraine as part of the compensation it is owed for Russia’s destructive war of aggression. There is no third option, except postponing the decision — and time is running out for that. For three years, Europe has delayed a decision. Now it has to choose. And the longer it delays, the more its power will erode since it will be ever harder to oppose a US-sponsored deal.

The other point is about non-EU democracies. Sixteen per cent of Moscow’s cash claim on Euroclear is in sterling — at the last reporting date, this meant about £25bn. To match this, Euroclear holds £25bn on its own balance sheet in UK institutions — I understand some are on deposit with the Bank of England and some in private correspondent banks. But being in Euroclear’s name, this is not immobilised under UK sanctions rules. (What is immobilised directly is an unpublished, but very probably much smaller, amount in the CBR’s own name.)

So whether this money is used to honour a Russian withdrawal request depends entirely on a decision made (or not made) in Brussels in July. It is astonishing that the UK political class does not find this an affront against UK sovereignty. The same point holds for Canada, where Euroclear holds about C$22bn (US$15bn).

Returning the money to Russia would be a strategic disaster. Not only would it cement Moscow’s advantage over Kyiv, undermining everything Ukraine has done, and Europe has helped it with, over the past three years. But it would also show that even when Europe has power, it will not use it. So who will be deterred by any other capacities — including military — that Europeans now say they will build up? Even tanks and missiles are only as powerful as the willingness to use them in extremis.

Whenever challenged on the blocked foreign exchange reserves, officials and politicians claim they need time to understand the complications. Don’t let anyone say this. There has been plenty of time for analysis, and everything has, in fact, been analysed. What remains is the act of choosing. So let’s repeat the answers to the main objections:

Legality. It is said confiscation is impossible under international law. But many legal routes have been identified — this summary paper for the European parliament sets them out.

Besides, there is no need to confiscate — to forcibly remove the CBR’s title to its assets — in order to transfer their value to Ukraine. As I have described before, bank regulation can be used to segregate the Russia-related assets and liabilities into a separate banking entity, split off from Euroclear Bank. This new bank could be bought by a consortium of friendly states and reincorporated in one of them. The consortium could instruct new management to move the bank’s assets from cash to Ukrainian reparations bonds — bonds paying out when Moscow compensates Kyiv — or a trust fund whose financial decisions are tied to reparations.

Precedent. Making the choice to use foreign exchange reserves to enforce compensation for a war of aggression — rather than waiting for a peace treaty where the aggressor may dominate — would set new precedent. But as no lesser an economic figure than Olivier Blanchard points out, the precedent would be a good one. It would say that countries that most gravely breach international law should not expect its protection. And it would say that Europe will put real power behind its words.

Financial consequences. Many objections are made along the lines of “harming the euro” as foreign central banks would pull their money out. Most are economically illiterate. First, there isn’t anywhere else for reserve managers to go. Second, the euro is a freely floating currency; there isn’t a target level for it. If it falls a bit, it falls a bit. So what? Third, the Eurozone does not depend on foreign capital. It is currently a huge exporter of capital. As Mario Draghi has emphasised, Europe is failing to use all its savings at home. This is the opposite of a situation where foreign investors need to be kept happy.

There is one, and only one, real threat. That is to arrange a speculative attack on a Eurozone government’s sovereign bonds. Saudi Arabia and others have been reported to have made such threats. Paris is particularly vulnerable to these threats, facing tight budgetary problems and still shell-shocked from almost ending up on the wrong side of markets in the Eurozone sovereign debt crisis.

But the Eurozone is well equipped to forestall such a hostile act. The European Central Bank’s “Transmission Protection Instrument” is designed precisely to prevent an unwarranted rise in a country’s borrowing cost. The ECB would not be doing its job if it failed to use it when needed — and it behoves the ECB to make clear that it would. The Eurogroup of finance ministers, too, could usefully make a statement of its confidence that the ECB had all the tools and willingness to use them to neutralise a politically motivated speculative attack on one of its members.

Servicing loans. G7 countries and the EU have started making “extraordinary revenue acceleration” loans to Ukraine, to be serviced by Euroclear’s profits on the blocked assets. Some politicians warn that transferring the assets themselves would remove that revenue stream. They forget to say that this would also happen if sanctions were lifted and the money went to Russia. But if the money goes to Ukraine, this is not a problem. The loans are in any case set up to be Ukraine’s liability — a liability it can much more easily service with the entirety of the assets than merely the profit stream from them.

Ukraine’s capacity to absorb. Even if the EU and its allies choose to favour Ukraine rather than Russia in this war, there are reasons to not simply hand over a few hundred billion to Kyiv in one go. One is that Ukraine can hardly absorb it all right away. Another is that the country still has corruption problems, and its political stability is hostage to how the war goes. But structures can be set up to disburse the money gradually. A trust fund, governed jointly by Ukraine and its European friends, could have a charter that would disburse money based on (a) acknowledged reparations claims; (b) any reparations agreed between Ukraine and Russia; and (c) Ukrainian reparation bonds. The portion used for (c) could be set to gradually increase to give Russia an incentive to concede in any talks over reparations.

To repeat: any need for analysis has largely been met. Any claim that further answers must be sought should be seen for what it is: plain political cowardice.

At the very least, Europe must forestall the return “by default” of the assets to Moscow in case politicians fail to decide anything. For the EU, that means acting now to segregate Euroclear’s Russia-related balance sheet in a new banking institution with targeted investment instructions. For the UK (and Canada) it means parallel moves to segregate Russia-related Euroclear funds in their jurisdictions and make them directly subject to domestic sanctions.

The time has come to make political choices — and the choices come down to favouring Russia or favouring Ukraine.

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