The real European financial threat to America

Paola Subacchi is professor and chair in sovereign debt and finance, Sciences Po, Paris. Paul van den Noord is an affiliate member at the Amsterdam School of Economics.

Could Europe’s $12.6tn holdings of US assets be used as leverage if relations with Washington sour further? That’s the question posed by FT Alphaville last month, and it’s a good one.

After all, Europe is collectively now the largest foreign holder of US federal debt, and also owns a vast amount of US real estate, stocks and other assets. In a world where economic relationships are increasingly weaponised — and the US dependence on foreign capital is greater than ever — it is tempting to think that this must confer some strategic power.

FTAV is essentially right: Europe’s US government debt holdings don’t translate into usable leverage, because most of them can’t be politically co-ordinated and selling would be self-defeating.

The reason is simple. “Europe” may hold a lot of US assets, but that doesn’t mean Europe can control them or deploy them as a co-ordinated political tool. Much of Europe’s exposure actually sits in private portfolios — pension funds, insurers, banks, and asset managers — not in a single public balance sheet that can be mobilised strategically.

But there’s an important distinction that tends to get lost in this debate. There are two very different stories here, and Alphaville only told one of them.

— A deliberate and co-ordinated weaponisation, where Europe uses its holdings as a bargaining chip; and

— A slow, decentralised buyers’ strike, as investors gradually stop adding to US assets.

The first much harder and, in practice, far less credible. But the second one is plausible. That’s why the “Europe has leverage because it holds a lot of Treasuries” framing gets the problem backwards.

The real leverage is not in selling what Europe already owns — which would be costly, destabilising, and largely self-defeating — but in stopping the accumulation of US debt. This is an intertemporal choice, not a tactical one.

Why a Treasury ‘sell threat’ isn’t real leverage

If Europe tried to weaponise its existing Treasury stockpile through sudden sales, the costs would land immediately on Europe itself.

A disorderly sell-off would push yields higher, reduce the market value of the remaining holdings, tighten global financial conditions, and almost certainly trigger spillovers into European funding markets. The act of “using” the leverage would destroy the asset value that supposedly gives Europe power in the first place.

This is why, historically, reserve adjustment almost never happens through dramatic liquidation. It happens through flows: less accumulation at the margin, gradual rebalancing, and slow substitution into other safe assets. 

Where the debate becomes more interesting is not the “weaponisation” story, but the slower one: whether foreign investors continue to provide the marginal demand the US relies on.

If Europe’s holdings matter strategically, it’s not because Europe can credibly threaten to dump Treasuries tomorrow morning. It’s because the US still depends on continued foreign inflows — and the marginal foreign buyer matters for pricing.

But this is precisely why it is difficult to translate holdings into leverage. The flow channel is slow, because portfolios adjust over years, and decentralised, because it reflects the behaviour of private institutions responding to returns, benchmarks, hedging costs, and liquidity needs.

So, if the question is narrowly “does Europe’s existing stock of US assets give it leverage in a confrontation?”, the answer remains “not much”.

China understood this a decade ago. It couldn’t and didn’t weaponise its stock of Treasuries in any meaningful way. Instead, it adjusted gradually — reducing the pace of accumulation and shifting the composition of its foreign asset holdings over time. The key lesson is not “sell your Treasuries to punish Washington”, but “change your marginal demand and your reserve composition quietly”.

As a result, China’s US Treasury holdings now stand at around $700bn, down from roughly $1.2tn in 2015. These figures could be misleading as some dollar holdings appear to have shifted into other parts of the state sector (including state-controlled banks), and to government-guaranteed mortgage-backed securities. Moreover, some public holdings may be routed through offshore centres. Even so, the core point still holds: China adjusted gradually at the margin rather than trying to weaponise the stock.

Why European demand for Treasuries should weaken over time

Even if Europe lacks a usable “asset weapon”, a separate question is whether the economic case for continuing to add to Treasuries still holds, given rising default risk and a declining convenience yield in a more fragmented global economy.

Foreign demand for US Treasuries rests on three pillars: perceived safety, convenience and returns. All three are weakening.

Let’s start with safety. This isn’t about an imminent, technical US default (though that is periodically flirted with). It’s about the creeping normalisation of ideas that would once have been unthinkable: selective default, political interference with debt repayment, or pressuring foreign creditors to accept worse terms. Even small increases in perceived default risk matter when holdings are large and investment horizons are long.

Next, convenience. US Treasuries are attractive not just because they are safe, but because they sit at the centre of a dollar-based trading and financial system. That convenience depends on openness. As Mark Sobel and Steven Kamin pointed out in Alphaville last week, trade restrictions, tariffs, and geoeconomic fragmentation all eat away at it. As global trade becomes less dollar-centric and more regional, the transactional demand for dollar liquidity declines, even when Treasury yields rise.

Then there is the intertemporal trade-off. Holding US debt has long allowed foreign investors to accept lower returns today in exchange for stability and liquidity over time. But that bargain looks worse when the US combines persistent fiscal expansion with trade barriers and signals indifference to creditor interests.

Higher yields may compensate in the short run, but they also imply a weaker dollar tomorrow. Once exchange rate dynamics are taken seriously, the long-run return advantage erodes quickly.

Put differently, Europe isn’t “trapped” into holding US Treasuries. It is choosing to do so — largely because private investors are chasing yield. But yield isn’t the same thing as safety, and short-term returns are not the same thing as intertemporal value.

The stock isn’t leverage, the flow is

FTAV is right to argue that Europe’s $12.6tn of US holdings doesn’t provide a credible, usable “weapon” in a confrontation. The stock isn’t politically controllable, and a forced sell-off would be self-defeating.

But it doesn’t follow that the current equilibrium will persist indefinitely. If Europe’s US allocation eventually declines, it will not look like a dramatic announcement or a co-ordinated sell-off. It will look like fewer incremental purchases, more hedging, more home bias, and slow substitution into euro-denominated safe assets — perhaps surreptitiously starting in certain long term pools of capital in smaller European countries.

That’s not leverage in the narrow, weaponised sense, but it is the mechanism through which the global financial equilibrium would change.

The policy implication for Europe is therefore not about confrontation, but about preparation: strengthening euro-denominated safe asset markets, improving co-ordination of reserve management, and giving European savers credible domestic alternatives. Over time, these steps would do far more to reshape the equilibrium than any symbolic attempt at retaliation.