Back to the Future

Thoughts on what to watch out for on Liberation Day 2.0, why Elon Musk is right, Denmark's pro-European turn, Greece's uncelebrated anniversary and the cost of Trump's breaking the last taboo

Photo by Joel Muniz on Unsplash

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I’ve not written anything on UK politics this week despite the dramas in parliament over the collapse of the government’s benefits bill because I didn’t have much to add beyond what I said last week. But the kind editors at Byline Times have removed the paywall from my column for this month’s edition where I explained why I have sympathy for Rachel Reeves. The good news is that after this week’s mini gilt market reaction to fears that she might be on her way out, Britain’s political and media class on both left and right may now better understand the dire predicament the country finds itself in.

In this newsletter:

• Liberation Day 2.0: Back to the future

• America Last: Elon Musk is right

• Denmark’s Turn: Towards the heart of Europe

• Greece’s Unmarked Anniversary: Ten years after THAT referendum

• Trump and Russia: Breaking the Last Taboo

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1. Liberation Day 2.0

On July 9, Trump’s 90-day pause on the “reciprocal” tariffs that he announced on “Liberation Day” will end. The markets already seem to have concluded that there is nothing much to worry about. The S&P100 last week hit a record high. Treasury yields are lower than a year ago. Investors seems to betting on the TACO trade (Trump always chickens out), American exceptionalism driven by AI optimism, expectations of a fiscal boost from Trump’s Big Beautiful Budget Bill, and a reluctance on Trump’s part to risk a recession ahead of next year’s mid-term elections, to offset any negative impact of higher tariffs.

That said, no one knows what Trump will decide, probably not even Trump himself. Needless to say, despite his boasts that he would strike 90 deals in 90 days, he has so far reached patchy agreements with only the UK and Vietnam. He now says that those countries with which the administration has reached an agreement in principle would remain on the current 10 percent baseline tariff (plus other sectoral tariffs), while those that have yet to reach a deal would revert to April 2 tariffs. Meanwhile those deemed not to be negotiating in good faith will be hit with Liberation Day-plus tariffs. Most countries will apparently be informed by letter next week what their new trading terms will be.

For all the market’s relative calm, negotiations with major trading partners have clearly not been proceeding well. The EU is balking at US demands that it exempt the US from its Digital Services Tax, Carbon Border Adjustment Mechanism and other non-tariff barriers. Talks with Japan appear to have all but broken down. Talks with India appear to have stalled over agriculture. Talks with Canada completely broke down until Prime Minister Mark Carney agreed to drop the country’s digital services tax. One danger is that Carney’s capitulation, plus the buoyancy of the markets, plus Trump’s sense of impunity following his Iran bombing campaign, will embolden him to driven an even harder bargain.

With that in mind, there are three things to watch out for:

1. Can the EU reach a deal? The EU has been trying to provide an off-ramp by suggesting it could live with a UK-style deal in which it accepted Trump’s 10 percent baseline tariffs along with some carve-outs from sectoral tariffs on products such as steel, aluminium and cars. But if Trump decides to hold out for the changes he is demanding to regulations and taxes, “reciprocal” tariffs of 50 percent could be on the cards, in which case a full-transatlantic trade-war would be on the cards. Goldman Sachs reckons a limited deal, which it thinks the most likely outcome, would hit EU GDP by 0.6 percent. But a no deal scenario in which tariffs rise to 20 percent of 50 percent would lead to a hit to GDP of 0.9 and 1.4 percent respectively. The latter could be enough to tip the eurozone into recession. I suspect this scenario is under-priced.

2. How does China respond? Beijing negotiated its own limited deal with the US in May to de-escalate a trade war in which Trump had raised tariffs on China to 145 percent. As a result, China has until August 9 to negotiate a full trade deal. But what little is know of the terms of the deal struck between the US and Vietnam will have rung alarm bells in Beijing. Vietnamese imports to the US will be hit with 20 percent tariffs but this will rise to 40 percent for “transhipments” - a clear attempt to avoid Chinese exports being re-routed via third countries. If the US uses tariff negotiations to try to squeeze China out of world markets, it is hard to imagine Beijing would not look for ways to retaliate. It has already shown that its dominance of the rare earths market and those for other critical minerals provides it with important leverage.

3. Does it hit the financial system? In the immediate aftermath of “Liberation Day”, I argued that it was hard to see how upending the global trading sytem could not end up causing trouble in the financial system. In fact, I was immediately vindicated when an extreme Treasury market sell-off forced Trump into announcing his 90-day pause. Since then, the markets have been betting on this so-called Trump put. Even so, the key longer-term question remains, as David Bowers at Absolute Strategy Research puts it, will the weaponisation of trade lead to the weaponisation of capital? After all, the elimination of the US trade deficit means the elimination of the US capital account surplus. That means a reduction in the cross-border capital flows that fund not only the government’s deficit but also the vast private capital funds that play an increasingly important role in the US economy. Likewise, will foreign investors reduce their exposure to US assets?

Given Trump’s total disdain for the global rules-based system, his obsession with trade deficits, his delight in the exercise of hard power and the hostility he has shown towards allies, it is hard to see him backing down entirely. We could be in for a volatile summer - even if the markets choose to stay on the beach.

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2. America Last

There has been plenty of coverage over the past week of the impact of Trump’s Big Beautiful Bill on the US national debt which is now forecast to rise by a further $3.3 trillion by 2035, according to the Congressional Budget Office. There has also been quite a bit of amused commentary the rift that the passage of this bill has reopened with Elon Musk. The Tesla boss now says that he will launch the America Party to oppose the Republicans in next year’s mid-term elections. Both have important short-term implication for the US economy and politics.

But not enough focus has been given to the substance of Musk’s criticisms of Trump’s bill. He is surely right that, over time, it is the Trump administration’s assault on US climate policy and its decision to dismantle most of the incentives for electric vehicles and clean energy that may prove to be the most consequential aspects of the BBB. Here are Musk’s posts on X:

The reality is that Trump is doubling down on the fossil fuel technologies of the 19th and 20th centuries just as China is powering its way to global dominance in the clean technologies of the 21st century. As the New York Times noted, in May alone, solar panels in China generated as much energy as one-third of all American power generation, combined. What’s more, China’s lead in clean technologies is only going to grow. Already this year, its biggest automaker, biggest battery maker and biggest electronics company have each introduced systems that can recharge EVs in just five minutes.

Leaving aside the consequences for the planet, Trump’s decision to turn his back on clean energy could have huge economic repercussions. Solar panels and windmills are currently the fastest-growing sources of power in the United States, accounting for 80 percent of new energy being added to the grid. But thanks to the cuts in the BBB, half a trillion dollars worth of planned investments could be at risk and, by some estimates, the amount of new electricity bought onto the grid could fall by up to 344 GW, enough to power half the homes in America. This at a time when, according to the Washington Post:

To keep up with the demands of AI and other industries, federal regulators say the United States needs to add to its grid by 2035 the amount of power used by all of California, Texas and New York combined.

The Trump administration says that any shortfall can be made up by a big expansion of gas and nuclear power. But this could take years:

There are no major new nuclear plants under construction, and they can take a decade or more to build. A global backlog of gas turbines means it can take five years just to build a single gas-powered plant.

The result could lead to rising US electricity prices while strategically important infrastructure such as AI data centres ends up located overseas, in places like the Gulf which are making vast investments in solar and battery installations. That alone poses risks to US exceptionalism. Meanwhile China will continue to export its own cheap, clean energy technology, much of which was invented in the US, to the rest of the world. Perhaps Trump thinks that he can somehow kill the clean energy sector globally and thus neutralise this Chinese advantage. If so, like Musk, I suspect it is a bet America will lose.

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3. Denmark’s Turn

There are plenty of reasons to be anxious about Donald Trump’s influence on European politics, which threatens to weaken the continent by fuelling MAGA-inspired far right populist parties that will deepen political fragmentation. But some reasons to be hopeful too. A case in point is Denmark, which last week took over the presidency of the Council of the European Union.

Until recently, Denmark stood out as one of the most eurosceptic countries in the EU. It secured opt-outs from the single currency, justice and home affairs, and the EU’s common security and defence policy, which it feared could undermine American commitment to NATO; it voted no in three referendums on EU issues; it was opposed to EU enlargement; and it was one of the “frugal four” that was hostile to expanding the EU budget and further issuance of common borrowing.

Yet in the last few years, it has undergone a remarkable pivot. When Mette Frederiksen became prime minister in 2019, she had a reputation as a traditional eurosceptic. Today, her mission is to put Denmark at the “heart of Europe”. This comes in response to a series of shocks, including Brexit, which deprived Denmark of a eurosceptic ally, the Covid pandemic, Russia’s invasion of Ukraine, and now the return of Trump, with his demands to annex Greenland. As a new paper for the European Council for Foreign Relations notes, Denmark has:

• held a referendum which abolished the EU defence opt-out and enabled Demark’s participation in the EU’s security and defence policies.

• reversed long-held positions on the EU budget, common debt and state aid; it left the “frugal four” and accepted the use of common debt and state aid for targeted purposes.

• where Denmark once played a sometimes passive role in the EU, it is now far more active—occasionally even assuming the role of chief whip when fellow member states fail to deliver on defence.

• once again become a strong advocate for enlargement, arguing that only a Ukraine within the EU and NATO can be safe and prosperous.

What’s more, this pivot towards greater European integration commands support from a Danish public that has traditionally been more eurosceptic than its politicians. In a recent ECFR poll, 67% of Danes believe the EU functions well or somewhat well—significantly higher than in other member states. Danes are now also among the strongest critics of Trump: 76% of respondents believe he is bad for America, and 78% believe he is bad for Denmark, while also fearing that its own government is not spending enough for defence.

As such, where Denmark’s government and citizens had for decades perceived its EU membership as an economic project, they see it now first and foremost as a matter of national security.

That is quite the pivot. Let’s see if others follow.

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4. Greece’s Forgotten Anniversary

Last week marked the 10th anniversary of an event that many would rather forget: Greece’s referendum on whether to accept the bailout package as an exit from its debt crisis. I remember the occasion very well, having spent a large chunk of the previous five years covering every twist and turn of the eurozone debt saga for the Wall Street Journal. This was the defining moment, when the young radical left-wing prime minister, Alexis Tsipras, led a defiant campaign against the deal.

Many assumed that the referendum result would lead to Greece’s exit from the euro. Instead, Tsirpas fired Yannis Varoufakis, his clueless finance minister who was chief architect of the government’s ruinous brinkmanship, and agreed to take the bailout. Perhaps it was only by taking the country to the brink that Greeks could ever be persuaded to support for what was certainly a very tough deal.

That said, I argued at the time that the deal was much better than was commonly recognised. Sure, it demanded some harsh austerity in the form of short-term budget surpluses. But it also provided some extraordinarily cheap, fixed-rate concessionary financing which would over time provide a form of substantial debt relief. Indeed, its average annual gross financing needs — the money it requires to borrow and repay maturing debt and interest — are now 6.2% of GDP through 2070 - among the lowest in Europe.

Above all, reforms to the public sector required by creditors to put debt on a long-term sustainable footing were desperately needed. Greece in 2009 at the start of the crisis was a semi-modern state, with a vastly bloated public sector, a completely unaffordable pension system that had been used as a general purpose welfare system, and an economy rife with corruption and clientelism.

A decade on, that optimism appears vindicated, as is clear from this long read by Bloomberg marking the anniversary. In recent years, Greece has been one of the eurozone’s faster growing economies. Debt has fallen from a peak of 207 percent of GDP to 153 percent at the end of last year and is forecast to fall to 146 percent this year. Unemployment has fallen from 27 percent to a 17-year low of 7.9 percent. The country’s 10 year bonds now trade on a yield of just 3.3 percent, lower even than Britain and the tightest premium over German bunds since 2008. Greece’s decision to stay in the euro has been entirely vindicated.

Nonetheless, not all is quite as well as it seems. Much of the growth has come from tourism, with other sectors not performing well. Investment levels are low, particularly in housing, which has become a hot button political issue. Wages remain well below 2015 levels in real terms. Large-scale emigration by younger generations in particular has left many sectors facing worker shortages. The country has been running current account deficits, suggesting it is once again consuming more than it is producing, leaving it reliant on foreign capital.

Most worryingly, there are signs of reform fatigue amid a paralysed and polarised political system. Kyrios Mitsotakis, the prime minister since 2019, won a comfortable majority in 2023 but his government has since become embroiled in a series of corruption scandals, some of which have involved his family and advisers, that has sapped his authority. In recent trips to Greece, I heard frequent complaints that the old clientelism is returning. Mitsotakis remains in place because there is no obvious successor. I even heard business leaders wondering if it might not be for the best if Tsipras, who is mulling a comeback, were to return. That is not something I could have predicted 10 years ago.

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5. The Last Taboo

Trump’s assault on the international rules-based order extends well beyond trade. He has also repudiated the central tenet of post-war international law: the prohibition on the use of force to resolve disputes and respect for national borders. It is not just that he is ready to recognise Russia’s territorial conquests - and is actively aiding Moscow’s attempts to seize more Ukrainian territory by cutting off military support. He barely bothered to pretend his decision to bomb Iran was based had any legal pretext in international law. And, of course, he has talked openly of annexing Panama and Greenland, and taking control of Gaza.

A terrific essay in the latest edition of Foreign Affairs by Oona Hathaway, Professor of Law at Yale Law School, traces the history of the modern taboo against the use of force to resolve disputes and seize territory and explains why its breakdown under Trump is so worrying. The first thing to note is both how recent this taboo is - and how successful it has been:

During the nearly eight decades after the UN Charter entered into force, the kinds of interstate wars and territorial conquests that had shaped and reshaped national borders for centuries became rare. Great powers have not openly fought a war against one another since 1945, and no UN member state has permanently ceased to exist as a result of conquest. Conflict, of course, has not disappeared, but it has become far less prevalent. The century that preceded World War II saw over 150 successful territorial conquests; in the decades afterward, there have been fewer than ten.

A second point to note, of particular relevance to Wealth of Nations readers, is the extent to which the success of the prohibition on territorial conquest has been a central factor in the economic success of recent decades. That is because it has altered the ways in which countries can acquire wealth:

Before this rule was established, states’ ability to accumulate wealth often depended on how much territory, resources, and concessions they could capture from other countries. War and conquest were recognized paths to prosperity. By eliminating the right to conquest, the postwar legal order forced states to seek economic growth through peaceful means, primarily trade. The expansion of trade and the prohibition of war went hand in hand, as states could no longer enrich themselves through conquest. Instead, they had to rely on economic cooperation, market competition, and the free flow of goods and capital.

The key point is that America has until now played a critical role in maintaining and defending the international legal order, even if not always consistently, as was clear from its own interventions in Iraq and Afghanistan. But if the prohibition against the use of force is collapsing, then we are into a very different world in which geopolitics becomes once again a “raw contest of military power”:

The consequences will be grave: a global arms race, renewed wars of conquest, shrinking trade, and the collapse of the cooperation needed to confront shared global threats.

All the more reason for small and middle-sized countries, who have most to lose from a return to a world in which the big powers are free to terrorise countries in their sphere of influence, to club together to try to maintain as much of the international legal order as possible. That starts with supporting Ukraine.