Europe is vulnerable to a new trade war, with its big trade surplus with America, historically low defence spending due to a reliance on NATO and America’s military shield, weak economic growth, highly indebted economies and a rise in populism promoting extremist politics.
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It is particularly vulnerable to the way Trump defines trade restrictions. He’s targeting not just trade surpluses and comparative tariff rates but Europe’s value-added taxes, France’s digital service taxes and any European policy that he believes disadvantages the US or its companies.
If he carries through with his threats, Trump would effectively be dictating Europe’s domestic tax, economic and social policies.
Yet, confronted by what would appear to be dire threats, the euro has been strengthening rapidly against the US dollar, Europe’s stockmarkets are booming and confidence in Europe’s economic outlook has grown.
Since the start of the year, the European sharemarket is up more than 12 per cent – Germany’s has risen nearly 15 per cent – and the euro has strengthened about 5 per cent against the US dollar, which has been weakening against the currencies of its major trading partners. The US dollar has fallen about 3.6 per cent against the basket of trading partners’ currencies in the past 10 days alone.
Trump’s decision to turn his back on more than three-quarters of a century of alliance with Europe and the post-war institutions and rules the US played such a dominant role in creating, and more recently, his decision to force Ukraine into a peace deal with Russia on Russia’s terms, has galvanised Europe.
Friedrich Merz, Germany’s new chancellor.Credit: Getty Images
Last week, European Union leaders endorsed a plan to lift budget restrictions on defence spending, deploy EU funds for regional security purposes and provide €150 billion (about $260 billion) of loans for military spending.
Germany’s new chancellor, Friedrich Merz, is rushing to agree on a deal with his probable coalition partners to relax Germany’s debt rules – remove the so-called “debt brake” – to fund €500 billion of infrastructure spending and unlimited borrowing for defence spending.
Germany’s economy has been moribund since Russia’s invasion of Ukraine blew up its economic model of exploiting cheap Russian energy and a euro whose value was depressed by the weaker economies of Southern Europe to export high-value manufactured products, particularly autos.
The scale of spending now proposed, provided Merz can get it through the German parliament before March 25 – when a new post-election parliament with enough far-right and far-left members to block the supermajority required for approval is formed – would be the biggest stimulus Germany has experienced since its reunification in 1990.
That level of stimulus to the EU’s biggest economy would significantly boost German and European economic growth.
In other words, Trump’s disdain for Europe and his trade policies and efforts to impose his peace plan on Ukraine and Europe, while withdrawing US military support for Europe, is forcing Germany to abandon long-held conservative fiscal and defence policies and resume an economic, political and military leadership position within Europe that it has largely shunned since the end of WWII.
Unlike most of the rest of the EU, where debt levels above 100 per cent of GDP (France’s is above 112 per cent) limit government’s ability to significantly increase spending, Germany’s debt-to-GDP ratio is only about 63 per cent. It has the capacity to do far more.
The EU’s decision to remove defence spending from the constraints it imposes on the deficits and debts of EU economies and provide loans from its resources is also stimulatory.
None of what the EU and its members plan (assuming they follow through) is likely to fully offset the impact of Trump’s tariffs or Europe’s inevitable retaliation – and Trump’s retaliation to that retaliation – but it should soften the blows by proving a massive, defence-led boost to the European manufacturing industry. Germany’s defence-related companies’ share prices, for instance, have rocketed.
A European Union abandoned by the US will have to chart a more independent course. The UK has notably become more closely engaged with the EU and their responses on Ukraine than it has been in the post-Brexit era. It may be that the EU also looks to a deeper economic relationship with China if its exports to the US are treated as harshly as Trump’s rhetoric suggests.
If it can generate reasonable levels of economic growth and the US economy shrinks under the weight of Trump’s erratically implemented economic policies, the euro could strengthen further, as might its appeal in a Trumpian environment, as a reserve currency.
Trump’s policies will have unintended consequences for the US and others and may inflict significant self-harm on the US for modest long-term gains, if any, while driving America’s former closest allies to do things they might never have previously contemplated.
