The Trickery of The EU Defence Fund

As part of their Total Reset Starmer and Rachel Reeves intend to design the next EU fund, mooted at €130 billion. This will ape the accounting trickery in the design of all previous EU funds.
An EU-level supranational entity will be established to incur borrowings, sparing member states from making borrowing themselves. The debt bypasses the member states’ national debt figures, allowing General Government Gross Debt to remain static. The proceeds of the debt will be spent in the member states, increasing their Gross Domestic Product figures. The result is a false improvement in member states’ Debt-to-GDP Ratios. Member states’ total financial liabilities increase, but a large part lurks in the shadows.
This was the message of my book, ‘The shadow liabilities of EU Member States, and the threat they pose to global financial stability’, published in 2023 by The Bruges Group. It is also the kind of accounting trickery that Reeves is rapidly introducing into the UK.

The defence fund will borrow from international investors and purchase defence equipment with the proceeds. The member states that sell the largest volume of equipment to the fund will see the biggest increase in their GDPs, and the biggest reduction in their Debt-to-GDP Ratios.
The defence fund will have no income to meet the interest and repayments on the bonds it has issued to international investors. Defence equipment generates costs – for crewing, storage, and maintenance – not revenues: ‘Nervos belli, pecuniam infinitam’.
It is the member states collectively – including the UK – who will make sure that interest and repayments on the bonds are met, regardless of what the money was spent on, or where.
This was the essence of all previous EU funds.

The European Stability Mechanism (ESM), the European Financial Stability Facility (EFSF), and the European Financial Stabilisation Mechanism (EFSM) raised money to make bailout loans to Ireland, Portugal, Greece, and Cyprus. Investors were willing to lend to these funds because the other member states guaranteed to pay what the fund owed to investors if the fund’s debtors - Ireland, Portugal, Greece, or Cyprus - were unable to pay what they owed to the fund.
At least these funds had an income stream that would cover all debt service as long as the fund’s debtors paid up. The ‘Next Generation EU’ Pandemic Recovery Fund deviated from this pattern. Next Generation EU was mounted through the legal person of the European Union, and it has raised over €750 billion so far, and distributed it as grants, as well as in the form of loans.
The existence of the grants portion ensures that the EU will have a shortfall of over half of the repayment amount. There is no debtor under the grants portion obliged to pay money back to the EU. The grants amount will be added, one way or another, to the member states’ payments into the EU budget – the 7-year Multiannual Framework - under its next three or four iterations.

Backstopping all of this is Germany: with a large economy, creditworthy, and with the capacity to take on extra debt itself to bail out these funds, this capacity equating to around 22½% of its GDP or €1 trillion.
Germany is at risk for the whole amount of ‘Next Generation EU’ and the EFSM, the guarantee structure being on a joint-and-several liability basis: every member state is responsible for the entirety.
Germany’s risk is capped – but at a very large amount – under the ESM, EFSF, and the European Investment Bank (EIB).
The strong EU member states guarantee the liabilities of the weaker ones.
The other strong EU member states holding a public credit rating of at least AA in the Standard and Poor’s system are the Netherlands, Luxembourg, Sweden, Denmark, Austria, Finland, Ireland (although it has not paid off its bailout debts from 2010), the Czech Republic, and Slovenia. However, they are too small for their guarantees to enable meaningful amounts of money to be borrowed by a new EU supra-national entity.
Step forward the UK, with both a large economy, and an AA credit rating. The EU will see us as they always did: as a good source of cash, and as good for guaranteeing the debts of the weaker, over-spending member states.

It was a prime reason for – and benefit of – Brexit that the UK no longer had to stand guarantor for the weaker EU member states, and that we need concern ourselves no longer with the levels of bad loans in Italian banks, or with the capacity of France to pass a budget through its parliament, or with the adherence of Greece to the terms of its bailout.

Starmer and Reeves intend to drive us right back into that morass, having promised in the Labour manifesto not to do so.