Europe's Moment of Truth
Thoughts on why Europe should call Trump's bluff on Ukraine; why a common defence fund is a test of European seriousness; and how Europe can seize Russia's frozen assets legally
A big welcome to new subscribers and particular thanks to those who have become paid subscribers. It is your support that enables me to keep this newsletter going and the more people who do subscribe, the more ambitious I can be with this project. For those who are unable to afford a paid subscription, you can still show your appreciation by sharing this newsletter widely. This week I have taken a breather from Trump tariff madness to look in more detail at the other big crisis that has dominated the European agenda that may be coming to a head. As always, I look forward to your feedback and comments.
In this newsletter:
Trump’s Ukraine Peace Deal: Not so divine intervention
Common European Defence: A test of seriousness
How to Seize Russia’s Frozen Assets: what are we waiting for?
1. Not so Divine Intervention
Who knows what was said in that 15 minute meeting between Donald Trump and Volodmyr Zelensky in St Peter’s Basilica on Saturday. Perhaps the encounter really was, as various media outlets have suggested, Pope Francis’s final miracle. Hopes that the US president may be backing away from his threat to abandon Ukraine if it did not sign up to a humiliating surrender were fuelled by a social media post in which he asked the question that the whole world has been asking: is Vladimir Putin just “tapping me along”? He even threatened to tighten sanctions on Russia, though he has said that before and nothing has come of it.
If there has been a shift in the US position over the last few days, it is likely to be as a result of divine intervention so much as a brutal confrontation with worldly reality. As the Wall Street Journal has noted, in the space of the last week or so, the wheels have started to come off the “never surrender” president’s effort to upturn the global order. He has had to backpedal on his crackpot “reciprocal” tariffs in the face of market mayhem, sue for peace with China and abandon efforts to fire the Federal Reserve chairman. He has suffered multiple defeats in the courts and has seen his favourability ratings slump. Ahead of his 100th day in office on Tuesday, Trump may be discovering the limits of his power.
This time last week it looked as if Europeans were about to be confronted by an impossible choice. Should they pressure on Kyiv to accept a “peace deal” based on terms cooked up between Washington and Moscow even though this would have left Ukraine vulnerable to Putin resuming his territorial ambitions and thus increased the risk that a post-conflict Ukraine becomes a failed state? Or should they continue to back Kyiv to fight on despite Trump’s threat to walk away from Ukraine, risking a deeper transatlantic rift that could raise fresh questions about America’s commitment to wider European security?
Of course, Ukraine and Europe may still be confronted with this choice. Trump claims that Putin has made a “pretty big concession” by abandoning its attempt to take the whole country. That would be a big concession if Putin meant it, given that controlling all of Ukraine has been a core Kremlin objective since its disastrous intervention in the 2004 election that sparked the Orange Revolution. But Putin’s concession means nothing unless without robust security guarantees for Ukraine and funding for its reconstruction. The US peace proposals presented to the Europeans in Paris on April 17 had little to say on either.
Meanwhile, it is hard to dispel the suspicion that what Trump really wants is not so much a peace deal as an exit strategy to allow for a rapid reset of commercial relations between America and Russia. Indeed, this piece in the New York Times sets out the many remarkable ways that, even leaving aside Ukraine, Trump has pursued a raft of polices that play directly into Moscow’s hands:
Mr. Trump has been tearing down American institutions that have long aggravated Moscow, such as Voice of America and the National Endowment for Democracy. He has been disarming the nation in its netherworld battle against Russia by temporarily halting cyberoffensive operations and curbing programs to combat Russian disinformation, election interference, sanctions violations and war crimes.
He spared Russia from the tariffs that he is imposing on imports from nearly every other nation, arguing that it was already under sanctions. Yet he still applied the tariff on Ukraine, the other party he is negotiating with. And in a reversal from his first term, Politico reported that Mr. Trump’s team is reportedly discussing whether to lift sanctions on Russia’s Nord Stream 2 gas pipeline to Europe, a project he has repeatedly condemned.
Yet while Trump’s desire to do business with Putin is obvious, the lesson of the last 98 days is that when confronted by determined opposition, Trump backs down. Those who have stood up to him, including Canadian prime minister Mark Carney or China’s President Xi Jinping have prevailed. At the same time, as Janan Ganesh acutely observed in the Financial Times, those self-styled “Trump whisperers” who have tried to ingratiate themselves with the US president, unfortunately including Britain’s Sir Keir Starmer, typically have nothing to show for it. One might also add that judging by polls in Canada and Australia, standing up to Trump reaps domestic political dividends too.
Hopefully that lesson is not lost on Europe’s leaders. Could Trump really walk away from Ukraine and abandon it to Russia? Even a week ago, his threat had to be taken literally and seriously. Now? Not so much. Even this most capricious and transactional of presidents appears may be starting to appreciate, if not the value of allies, then at least the cost of turning them into adversaries. Europeans should stand their ground and call this bully’s bluff. It might even lead to a deal that everyone can live with. Now that really would be a miracle.
2. A Test of European Seriousness
Europeans would be in a far stronger position to support Ukraine if they were in a position to provide those robust security guarantees themselves. Instead, the last few weeks have exposed vast gaps in European capabilities. Britain and France have struggled even to put together a “coalition of the willing” that can provide a barebones peacekeeping force to send to Ukraine, let alone make up for the loss of US capabilities should Trump decide to withdraw support for Ukraine, not least in terms of key “strategic enablers” such as air defence and intelligence.
The good news is that everyone now agrees that Europeans need to address these deficiencies, not least because regardless of what happens in Ukraine, it is obvious that Europe can no longer rely on American security guarantees in the long-term. Germany has relaxed its debt brake to allow for up to €1 trillion of extra defence spending over the next four years. The European Union has created a new mechanism to allow member states to borrow cheaply to fund defence and tweaked its fiscal rules to exempt defence spending from calculations of national debt. It reckons the two measures could lead to an extra €800 billion of spending.
The bad news is that this is not enough. Nato secretary general Mark Rutte has said that alliance members are going to need to raise their defence spending to “considerably more” than 3 per cent of GDP. What’s more, tweaks to fiscal rules and cheap loans will not help many highly indebted EU countries for whom the hard constraint is the bond market: any interest saving from accessing EU loans is likely to be wiped out by higher interest charges on the rest of their debt. Meanwhile no European country on its own is going to provide those “strategic enablers” that are currently provided by the Americans.
But there is a way forward for Europe - and whether Europeans choose to take it is a critical test of the continent’s seriousness that it cannot afford to duck. An important new paper published by Bruegel, a Brussels-based think-tank, offers a compelling proposal for a new European Defence Mechanism that could transform the defence capabilities of the continent. The authors, Guntram Wolf, Armin Steinbach and Jeromin Zettelmeyer, are highly regarded economists. They start by setting out the key challenges facing European rearmament:
the European defence equipment market is is characterised by low production numbers, high fragmentation, limited competition and strong home bias in procurement. Even large countries often order products such as tanks in only small quantities. For example, since 2022, Germany has ordered only 123 Leopard 2 tanks to be delivered by 2030. European countries operate 12 different main battle tanks, while the US has one..
the high degree of home bias leads to excessive product differentiation and higher prices. Germany, for example, buys almost half of its equipment from domestic producers and around an additional 30 percent from domestic joint ventures, while the sales of the top two French companies account for 69 percent of the sales of French defence companies.
the European defence industrial base does not provide some key modern arms technologies, leaving Europe reliant on US systems. These include fifth-generation fighter jets, certain air-defence systems, rocket artillery systems similar to the US HIMARS and heavy transport helicopters. Europe also relies on US software and satellite-based communication and intelligence.
the EU has never been able to deliver an effective single market in defence equipment because the EU Treaties contain a specific carve-out for the sector from single market rules (Article 346). That makes any attempt at EU level to create more efficient common procurement legally unenforceable
the EU is not an optimal institution via which to create a pan-European defence procurement market because it excludes some of Europe’s key defence players, including Britain, Norway and Switzerland, while including some countries whose constitutionally enshrined neutrality complicates their participation in common European defence initiatives
The creation of a European Defence Mechanism could get around most, if not all of these problems. Firstly, it would be a pan-European common defence fund that is outside the EU and open to a coalition of the willing including non-EU countries such as Britain and Norway. Second, it would be based on a new intergovernmental treaty which would enshrine the principle of non-discrimination, thereby circumventing the problem of Article 346.
The result is that an EDM would be able to pool orders for defence equipment and put them out to competitive tender, thus addressing the problems of low order sizes, market fragmentation and home bias. Drawing on management literature, the authors reckon that based on the kind of increases in demand for equipment that Europe is likely to need in the coming years, such pooled orders could lead to falls in unit costs of up to 90 percent. That would give European governments far greater bang for their rearmament buck.
Best of all, the debt taken on by the EDM to pay for new equipment would not show up on national balance sheets. Governments would only hand over their own money to the fund when they took delivery of equipment. And to the extent that the fund purchased common public goods such as satellite systems or a common European air defence, these could be paid for by annual service charges.
It’s true that what is being proposed will force governments to confront tough choices. For countries such as Germany and the Netherlands that have long resisted common European borrowing, it would mean overcoming another taboo. For Britain, which quit the EU less than a decade ago, it would be a giant step back towards European integration. Many smaller countries will worry about the risks to their national defence manufacturing sectors.
But if Europe is to have any chance of remaining a pole in the fast-emerging multipolar world, what other choice does it have?
3. How to Seize Russia’s Assets
Another way in which Europe can and should act decisively to bolster Ukraine and thus its own security is to take action regarding Russia’s frozen assets. For the last three years, European policymakers have resisted calls to seize these assets, of which there are roughly €300 billion sitting in the European financial system, for the understandable reason that doing so could undermine international confidence in the European financial system. On the other hand, if there is a risk that America could withdraw its support for Ukraine, or that imposes a shabby peace deal, these funds could be critical in allowing Kyiv either to fight on or to rebuild its infrastructure and economy and boost its defences.
But there is a way to square this circle. In a recent paper, Lee Burkheit, one of the world’s foremost experts in sovereign debt, and Hugo Dixon, commentator-at-large at Reuters, proposed that Europeans offer Kyiv a Reparation Loan, ultimately backed by the frozen assets. The beauty of this arrangement is that it could provide Kyiv with up to €300 billion to Kyiv in a way that is legally watertight. It works as follows:
Holders of frozen Russian assets would lend Ukraine $300 billion.
In return, Kyiv would pledge as collateral its claim against Moscow for war reparations.
When the war ends, an International Compensation Commission would be established to assess Ukraine’s claim for war damages.
If the Kremlin refused to pay reparations, then Kyiv would be unable to repay the loan, in which case the lenders would inherit the claim against Russia.
The lenders would then set off that claim against the frozen assets.
The great thing about this proposal is that it relies on two established legal principles. First, that countries are required to pay reparations if they illegally invade another country. Second, that a creditor can "set off" a debtor’s assets against its unpaid debts. That makes it far more legally defensible that earlier calls for the outright seizure of the assets, which relied on the notion that a country is entitled to take "countermeasures" in response to an illegal invasion.
Of course, Russia would complain that any International Compensation Commission was a kangaroo court and thus refuse to accept its legitimacy. But the United Nations General Assembly voted overwhelmingly earlier in the war to establish such a mechanism, so the Europeans would be a solid ground.
The beauty of this plan is that it is something that Europeans could do very quickly, without the need for US permission. It would be a significant morale boost to Ukraine, giving them confidence that they will have money to buy arms if they choose to fight on and the funding for reconstruction if there is a peace deal. Above all, it would send a powerful signal from Europeans to Trump that they will not be sidelined or bullied. What are they waiting for?
Thanks, the older ones remember the pre-peace dividend level of taxation to keep a much bigger military
I think its fairly obvious that taxes will have to go up. But politicians don’t want to adress that elephant herd in the room.
Merz even waffled something about possible maybe tax reductions, right
Europe faces some tough choices that go beyond how to fund increased defense spending. Higher defense spending becomes easier with higher GDP growth rates, which European economies are already habitual laggards.
Add increased taxation and borrowing to already anemic GDP growth and you generally don’t have a viable long term strategy for success. At some point Europe will have to make the difficult guns vs. butter decisions.