After the TACO
Thoughts on the economic consequences for Europe of a tumultuous week
Welcome to this week’s newsletter. A warm welcome to new subscribers and my gratitude to paid subscribers who make this worthwhile. My attention last week was on the Greenland crisis and the risk of a collapse in the western alliance so I hope you will appreciate that it is the only topic this week! I will have more to say on a wider set of topics next week. As always, I look forward to your feedback.
Some thoughts on where Europe stands after a tumultuous week:
Europeans have been congratulating themselves on having successfully stood up to Donald Trump, forcing him to rule out the use of force to seize Greenland and withdraw the threat of tariffs against eight countries that had sent troops to the Arctic island. Investors welcomed the president’s retreat as more proof that Trump Always Chickens Out (TACO). On the other hand, Trump’s media sane-washers insisted the episode was evidence of his strategic genius, either because he secured everything he wanted (the Art of the Deal!), or (ludicrously) because it was all a tactical feint designed to deflect European attention from his activities in Iran and Ukraine. It is is impossible to say with certainty who is right since we don’t know what really lies behind Trump’s Greenland obsession (national security? profit? vanity?), let alone what was contained in the “framework” for Arctic security that Trump agreed with Nato secretary general Mark Rutte that prompted the climbdown.
Whether Europeans are right to be so self-congratulatory in believing that they have seen Trump off remains to be seen. Rutte says that sovereignty was not discussed, but multiple news outlets reported that the US could be allowed to establish sovereign bases on the island, along the lines of Britain’s bases in Cyprus or America’s at Guantanamo Bay in Cuba, along with preferential rights to the island’s mineral deposits. That would appear to cross the red lines of Denmark and Greenland, neither of which were party to the discussions. It is good that the issue has been kicked into the bureaucratic long grass, but Trump’s threat that “we will remember” if Denmark does not hand over sovereignty hardly suggests it has gone away.
How much Europe’s united front was a factor in Trump’s decision to deescalate as opposed to pressure from the financial markets or domestic political opinion is an open question. The reality is that Europeans were not quite as united as claimed. They may have all signed up to the proposition that Greenland’s future was a matter that only Greenland and Denmark could decide. But that formulation still laid open the possibility that Denmark and Greenland could decide on a future more amenable to Trump. Briefings about a Cyprus-style solution didn’t appear from nowhere. European unity might have been even harder to maintain if Trump had pushed ahead with his tariff threats. Britain effectively acknowledged that it would not retaliate, which is one reason why I warned in my latest column for Euractiv that Britain would be Europe’s weakest link when it comes to forging a united front to resist Trump. Whether the EU would have imposed a threatened €93 billion in retaliatory tariffs, let alone mustered the qualified majority necessary to launch its trade “bazooka”, the anti-coercion instrument, we may never know.
Whether it was European defiance or market pressure that forced Trump to back down matters for investors, as James Mackintosh noted in the WSJ. “If Europe thinks its stronger posture worked, it will be even more aggressive next time—and the risk of a trans-Atlantic tit-for-tat trade war rises.
If domestic politics was the driver, then investors can expect foreign threats to continue so long as Trump’s base doesn’t object—Cuba is the latest...
If the unknown, and as-yet unrealized, Greenland deal about military and, perhaps, mineral access turns out to be highly favorable to the U.S., investors in the U.S. might welcome gains for America at the expense of a Europe that has to kowtow to the hegemon… However, if his reverse is just Trump being mercurial, there should be a permanently higher risk premium, showing up in a higher Vix volatility index and lower stock prices than otherwise, because on any given issue he might not back down.”
Although the market sell-off before Trump’s Davos speech was relatively small and mostly reversed - the dollar was down 1.2% and the S&P 500 only 2.1% at worst on Tuesday from Friday’s close - this episode may have longer term economic consequences. Treasury Secretary Scott Bessent claimed that a report by Deutsche Bank’s chief currency strategist suggesting that the transatlantic rift could lead European investors to dump American assets had already been disowned by Deutsche Bank’s chief executive. Bessent was similarly dismissive of reports that a Danish pension fund is selling its holdings of US Treasuries, insisting that “Denmark is completely irrelevant”. It is true, as Toby Nangle noted in the FT’s Alphaville, that the idea that Europeans could systematically dump Treasuries as a way of exerting leverage is implausible. Apart from there being no obvious way to coordinate such action, given that most European holdings of Treasuries are in the private sector, nor is it clear to whom they would sell them. Nonetheless, European investors could decide to reduce their exposure to the US simply by buying fewer Treasuries, leading to a weaker dollar and higher bond yields.
Inevitably, one of the biggest beneficiaries of investor concerns over rising geopolitical risks and doubts over long-term dollar hegemony is the gold price. Last week gold rose to within a whisker of $5,000 an ounce and at this level, accounts for around 30 percent of global bank reserves. As Wealth of Nations noted last September (when the gold price was $3,750 an ounce and accounted for 20 percent of reserves), were gold to rise to an equal share of global reserves as the dollar, this could on current trends see the gold price rising to $8,500 an ounce over the next four years (see Loss of Faith). Meanwhile the gold frenzy has now spread to silver, up 13 percent last week and 300 percent in a year to close above $100 an ounce for the first time.
Meanwhile, the shockwaves from the Greenland crisis is likely to have ramifications for trade. The European Parliament is now threatening to refuse to ratify the EU-US trade deal, the one-sided agreement that Commission President Ursula von der Leyen struck with Trump last summer (see Europe’s Surrender), raising the prospect of US retaliation. That follows the Parliament’s decision to stall ratification of the EU-Mercosur trade deal the week before. As Mackintosh notes: “Faced with unpredictable trade relations, CEOs are already trying to shorten supply chains to reduce tariff risk. The danger of political retaliation based on nationality might also make companies less willing to embark on major projects overseas. In the long run, such deglobalization makes economies less efficient.”
At the same time, Europeans may seek to reduce their dependencies on US technology. As John Thornhill noted in the FT, “the region’s reliance on US defence companies, including tech firms such as drone maker Anduril and the data platform Palantir, looks reckless given Washington’s unreliability as a partner.” The growing transatlantic rift may - should - fuel European efforts to deepen defence market integration and support European start-ups. Similarly, Europe should try to disentangle itself from the broader US tech stack, says Thornhill: “According to one estimate, three US companies control 65 per cent of Europe’s cloud computing market. US companies also dominate AI foundation models, semiconductors, search engines, social media and messaging apps in Europe.”
Of course, reducing European dependencies on the US will not be easy. As a first step, it will require delivering on the reforms outlined in Mario Draghi and Enrico Letta’s reports to deepen the single market. A second challenge is to encourage Europe’s roughly €300bn annual savings surplus currently invested abroad to be redirected to finance European investment. Indeed, Erik Fossing Nielsen heretically argues that Europe should introduce tax and regulatory incentives to European holders of the stock of capital in the US (€12.5 trillion) to begin to move it to other and safer jurisdictions, closer aligned with Europe. Wealth of Nations has long argued that the weaponisation of trade was likely to end up with the weaponisation of capital (see The End of the World as We Knew It). This is not a path that anyone should want to venture down willingly. But perhaps Erik is right when he says: “It’s time to prepare for the previously unthinkable!”
The big danger for Europe now is complacency - that having apparently seen Trump off for now, that political leaders retreat back to their comfort zone. As I noted in my Bloomberg essay, the lesson of the 1930s is that in such a contested world, Europeans also need to build their deterrence, so they are better able to resist military and economic coercion, and defend themselves if deterrence fails. Yet, so far, fine words are not translating into sufficient action. With the exception of Germany, the pace of rearmament is slow. There is not yet any plan to replace the 40% of European defence capabilities currently provided by the US, including critical enablers such as satellites and logistics, let alone for the common borrowing needed to pay for them. Nor is there any sign that European electorates are willing to contemplate the cuts to welfare spending needed to fund higher defence spending.
Great note - and thanks for mentioning my points in “9”. I agree with almost everything, but just to be sure re “5” and “9”: My argument is not to dump US assets as a way to put pressure on the US. Rather, it’s purely defensive to reduce European exposure to assets which have become less safe - and to help finance European investment instead.
Thank you. This reinforces everything I have been thinking the past few days - Starmer needs to ignore polls, rejoin the EU, the EU reinvest in Europe and pull together with EU's not inconsiderate capabilities - we need to think strategically, not sit on fences - afterall, the other so called 'major players' are doing their own thing - it's a game of poker, not dominoes and.. no - time - to - waste!