Europe is entering a critical period. Two recent decisions by President-elect Trump underscore the challenges ahead:
Ukraine:
A former admiral, eager to end the conflict with Russia as quickly as possible, has been appointed to oversee U.S. policy on Ukraine. His goal includes significantly reducing U.S. arms supplies to Ukraine. Moreover, the Trump administration wants Europe to greatly enhance its military capabilities and assume the primary responsibility for Ukraine's security and funding. This effectively means Europe will need to increase defense spending substantially. Given the limited number of European arms manufacturers, much of this new equipment will need to be procured from the U.S., providing Europe with little economic benefit.
Import Tariffs:
While Trump’s intention to use import tariffs to influence trade flows was already known, it has become evident that he also plans to use them for geopolitical purposes. Recently, he threatened additional tariffs on imports from Canada, Mexico, and China to pressure these countries into curbing drug exports and preventing migrants from crossing the U.S. border.
Many countries are unlikely to tolerate such U.S. coercion for long and will likely implement countermeasures. Consequently, global economic and geopolitical tensions are expected to escalate soon after Trump takes office. This is particularly troubling for Europe, which is more dependent on international trade than any other continent. Furthermore, the ability of European countries to respond collectively remains uncertain. Without unity, individual nations lack the influence to shape outcomes effectively. Meanwhile, high government deficits and debt levels leave little room for fiscal stimulus to offset declining trade. This is especially true given the added financial burdens of increased defense spending, debt servicing, and aging populations.
Structural Challenges:
In his report, Draghi highlighted the rapid deterioration of Europe’s competitive position. To reverse this trend, Europe needs to significantly increase investment in research and development, foster the growth of large European technology companies and establish a unified capital market to finance these initiatives.
However, achieving these goals will take time. In the interim, governments must take the lead. Yet Europe faces two significant hurdles:
- France:
With an excessively large budget deficit, France is required under EU rules to implement significant reductions over the coming years. This is a daunting task, further complicated by deep political divisions. The potential for government collapse and ensuing political crisis makes charting a new course nearly impossible. - Germany:
Germany’s upcoming elections may pave the way for removing the constitutional limit on the budget deficit (currently capped at 0.35%). However, domestic and European regulations will still restrict the deficit to no more than 1%, leaving insufficient funds for a new strategic direction.
Conclusion:
Europe risks becoming trapped between rapidly increasing global economic and geopolitical tensions. Yet, this does not necessarily spell doom:
- Historically, when faced with dire circumstances, European nations have come together to implement the necessary measures.
- For now, the ECB can sustain the economy with adequate monetary stimulus, potentially shifting its focus slightly from inflation control to promoting stronger growth.
Best regards,