The Next Euro Crisis plus other continental horror stories

Thoughts on Season 2 of the Trump Tariff Show, Is France heading for a Greek-style debt crisis, how long can Russia's economy hold, is this a Bitcoin Ponzi scheme and why Angela Merkel failed

Photo by Ehud Neuhaus on Unsplash

In this newsletter:

• The Trump Tariff Show: Back on our screens

• Is France the new Greece? Three things to worry about

• Guns and Butter: Russia may soon have to choose

• A Bitcoin Ponzi Scheme? What’s driving the price surge

• Angela’s Ashes: Explaining Merkel’s dismal legacy

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1. The Trump Tariff Show

Last week the second season of The Trump Show started streaming in earnest. It began with Donald Trump’s appointment of Scott Bessent as Treasury Secretary, which was received with considerable excitement in the markets. The former hedge fund manager has been well-known to London’s financial community since he helped George Soros break the Bank of England with the $1 billion bet that led to sterling’s ejection from the European Exchange Rate Mechanism in 1992. One hedge fund manager who has known him for 25 years told me:

Bessent is sharp, has one of the best global macro brains in the world that I know, has unbiased judgment, understands markets as well as academia… A first class choice. The US dollar has a calm and rational head. It’s very important for global trade and financial stability.

But the optimism only lasted until Monday night when Trump posted on Truth Social that he intended to impose a 25 per cent tariff on all imports from Mexico and Canada unless they took action to protect the US border and a 10 percent tariff on imports from China. By the end of the week, the markets had calmed down again after Trump posted that he had a “wonderful conversation” with Mexican president Claudia Sheinbaum while Canadian prime minister Justin Trudeau dashed to Mar-a-Lago for what seems to have been a convivial dinner.

A few points can be drawn from this roller-coaster week:

First, we had better get used to these gyrations. It is clear that tariff risks will never be off the table in the second Trump presidency: he intends to use tariffs and trade as a key instrument of foreign policy as well as economic policy. That is worrying because it spells the end of what remains of the post-war global consensus on trade. In his first term, Trump did at least try to advance some kind of economic rationale for what he was doing on tariffs.

Second, even if Trump doesn’t follow through on the threats against Canada, Mexico and China he issued on Monday, the sheer scale of those threats is striking. As Goldman Sachs noted:

The opening salvo of Trade War Two comprised across the board tariffs on the three largest US trading partners that account for close to half of US goods imports. Though broad tariffs like this were proposed several times in the first term, a 10pp increase in China tariffs would roughly equal the entirety of Trade War One, and including a 25pp tariff on Mexico and Canada would come close to equaling the potential size of a baseline 10% tariff rate on all trade.

Third, while we can be confident that Trump will impose tariffs, if only because he needs the revenues to help fund his tax cuts, how he goes about delivering them will matter. As this Foreign Policy piece explains, the president has wide authority under various US laws to impose tariffs where he sees risks to national security. Nonetheless, all would require some degree of legal pretext, which would take time to assemble, would be subject to legal challenge, and would provoke retaliation. Meanwhile, an across the board tariff of 10-20 per cent, such as he proposed during the campaign, would require Congressional approval. It would also drive a coach and horses through World Trade Organisation rules which may be a step too far for some remaining pro-free trade Republicans.

What all this means is that despite all the headline grabbing social media posts last week, we are still not really much clearer on the plot lines for Season Two of the Trump Show. Over the coming months, his proposals will evolve into more detailed policy initiatives which will rattle the markets. As this rather technical piece by Richard Baldwin explains, much of the global economic adjustment to higher tariffs will be borne by the currency markets in the form of a stronger dollar. But there is still plenty of scope for Bessent to bring his calm and rational head to bear in the interests of global trade and financial stability.

Of course, what one is left with in the meantime is uncertainty - and as Goldman Sachs notes, that uncertainty may be already be having a chilling economic effect as a result of reduced investment and capital expenditure. That is likely to be a particular issue in Europe, which is braced at the very least for tariffs on its auto sector. As a result Goldman has reduced its forecast for euro area growth next year to just 0.8 per cent, compared to a market consensus of 1.2 percent.

To repeat: this is all just getting started.

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2. Is France the new Greece?

A Trump tariff growth shock will hit all European countries, but the political consequences may hit hardest in France where Michel Barnier’s minority government is struggling to pass a budget for next year. Marine Le Pen, the leader of the far fight National Rally, has given the prime minister until tomorrow to compromise on his €60 billion package of tax rises and spending cuts, or she says she will pull the plug on his government. That sent French bond yields last week to their highest spread above German bonds since 2012, leading the Financial Times to ask whether France is heading for a new Greek-style debt crisis.

The answer is almost certainly not. Greece in 2009 was a pre-modern state that had just revealed a giant hole in its accounts which sent bond yields soaring above 10 per cent, rendering its debt patently unsustainable. France, on the other hand, is one of the world’s richest countries with an effective public administration, a diverse economy, skilled workforce and, even after the latest sell-off, still only faces bond yields of about 3 percent. What’s more, the EU has undertaken wide-ranging reforms of its banking sector and institutional arrangements since the Greek crisis that make a repeat much less likely.

That said, there are three reasons why the situation in France is troubling:

The first is that the rise in bond yields makes a difficult fiscal situation even harder. Barnier is trying to bring down a government deficit of 6 percent of GDP, twice the limit under eurozone fiscal rules, to 5 percent by the end of next year. That target already looked highly challenging, not least because the bulk of the adjustment is due to come from tax rises which will sap growth. Goldman Sachs had already cut its forecast for French growth to 0.7 percent next year and expects a budget deficit of 5.4 percent - and that was before Barnier was forced to offer to scrap an electricity levy last week as a sop to Le Pen.

Barnier’s task will become even harder if the latest rise in bond yields persist. One problem is that higher yields will lead to higher interest costs, which are rising anyway as debt issued at very low interest rates pre-pandemic is rolled over. A second problem is that higher yields will feed through to higher private sector borrowing rates, acting as a further drag on growth. Indeed, the higher spreads have already unwound much of the impact of the European Central Bank’s recent interest rate cuts, thereby putting France at a competitive disadvantage. France now faces higher borrowing costs that Spain, Portugal and even briefly last week Greece. Italy’s borrowing costs are now just 0.4 percentage points higher.

The second concern is that it is hard to see what can bring an end to the political turmoil that is driving bond yields higher. Even if Barnier and Le Pen can agree a compromise that gets through next week, there will be other moments of political peril between now and December 20 when the budget must pass. Indeed, Le Pen could pull the plug on Barnier at any time between now and May 2027 when the next presidential election must be held, with an obvious window of an opportunity arising next June, when fresh parliamentary elections can be held.

Nor would the presidential election in 2027, assuming Macron lasts in office that long, necessarily bring any greater clarity. As things stand, it is quite possible, even plausible, to imagine a scenario in which the final round is contested between the right-wing populist Le Pen and left-wing populist Jean Luc Melanchon. Nor could one be confident that in today’s increasingly fragmented political landscape that the ensuing parliamentary elections would result in a majority government able to deliver much-needed fiscal and structural reforms.

The third worry is what consequences French political turmoil will have on the wider European reform agenda. After all, weak growth is hardly a French problem alone. As Mario Draghi made clear in his report into how to improve Europe’s competitiveness, action at the EU level is vital to deepen single market integration in areas such as digital services, energy, capital markets and defence. What’s more, some of these measures will require common European funding, not least because many member states are so highly indebted.

Yet big steps in European integration depend on two things that are sorely lacking in Europe right now, made worse by French political turmoil: leadership and trust. In particular, it would be even harder to convince sceptical member states to contemplate any increases in common borrowing to fund, for example, common European defence procurement, if France makes a mockery of the the eurozone’s new fiscal framework in the very first year that it is applied.

Rather than a Greek-style debt crisis, it is this steady evaporation of confidence in Europe’s ability to tackle its challenges that is most dangerous. Last week, I highlighted the risks arising from the extraordinary valuation gap that has now emerged between European and American stock markets. Perhaps rising bond yields will focus minds in Paris. My hunch is that Barnier will get his budget and that his government will limp on for longer than many expect. After all, it is not in Le Pen’s interest to be blamed for triggering a deeper crisis. But that is unlikely to be enough to restore global investor confidence in France or Europe.

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3. Guns and Butter

If the economic outlook for Europe is bleak, consider the state of Russia. I wrote a few weeks ago that the Russian economy was in deeper trouble than was widely recognised and that for all the military pressure on Ukraine to negotiate an end to the war, Moscow needs a deal too. Since then, the economic situation in Russia has clearly deteriorated further. The US decision to sanction GazpromBank, the last remaining Russian bank allowed to deal in dollars, sent the Ruble tumbling 8.5 percent in a day last week to its lowest level since the invasion of Ukraine. The central bank had already been forced to raise interest rates to 21 percent to head off inflationary pressures and now faces having to hike them further.

In theory, Russia’s war economy is booming as massive military spending, equivalent to 6 percent of GDP has led to buoyant growth, full employment and soaring wages. In reality, the economy is clearly close to over-heating. Officially, the Russian inflation rate is 8 percent, but the fact that interest rates are so high is evidence that the real rate is almost certainly higher. Butter prices have soared by more than 50 percent, leading to reports of butter thefts. Sky high interest rates threaten a wave of corporate bankruptcies. The Kremlin last month revised the compensation for dead and injured soldiers which had already cost more than $30 billion by June. At the same time, it has been forced to turn to North Korean soldiers and Yemeni mercenaries to plug gaps in its armed forces.

Meanwhile the bigger risk to Russia’s finances comes from falling oil prices. These have fallen to $68 a barrel as a result of over-production by Opec members and easing concerns of a wider Middle East conflagration. As I explained previously, that presents a particular dilemma for Moscow because oil revenues account for up to 40 per cent of the Russian state budget.

Given that the government is already running a deficit of around 1.5 per cent of GDP, equivalent to around $40 billion, and Russia is currently shut out of global capital markets, Moscow will be reluctant to let that deficit widen since this will eat more quickly into liquid reserves. Better to let the ruble fall, and preserve the value of oil revenues in domestic currency, even at the expense of even higher domestic inflation.

Of course, Russia is a totalitarian state so Vladimir Putin does not need to worry about the domestic political fallout from rising cost of living pressures to the same extent as leaders of western democracies. And one should not underestimate the ability of Russia’s widely respected central bank chief to keep the plates spinning. And when Russia’s budget deficits have burned through the estimated $50 billion of liquid assets that it can still access, it will no doubt be able to look to China for some kind of external financing arrangement.

Nonetheless, it seems clear that western sanctions are hurting the Russian economy to a greater extent than its dubious official statistics acknowledge. It is also seems likely that the Kremlin is heading for serious problems some time next year if the war continues and sanctions remain. That gives the West some leverage in the peace negotiations that Trump is expected to initiate when he enters the White House. Let’s hope he makes full use of it.

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4. A Bitcoin Ponzi Scheme?

I confess I’ve never been able to get my head around Bitcoin, though not for want of trying. But that’s clearly a failure of imagination on my part, judging by what has been happening to its price. Last week it rose to an all-time high of just short of $100,000, up from just $40,000 at the start of the year. It’s an astonishing run for an asset that does not exist in physical form and provides no income.

It is not hard to see what is driving these extraordinary gains. Part of it, as previously discussed here, is what can loosely be described as the dollar debasement trade, the search for safe havens for a world of currency debauchery driven by fiscal incontinence in developed markets. Gold, which is up more than 845 percent since the start of the century, has been a similar beneficiary of a desire by investors to diversify their holdings and find non-correlated assets.

A second driver is the expectation that the second Trump presidency could be very friendly for Bitcoin and other crypto assets. He is already known within that ecosystem as “the crypto president” having talked during the campaign of creating a US strategic Bitcoin reserve and his advisers have since the election talked of creating a role of White House crypto policy adviser. That has raised the prospect of more crypto friendly regulation, allowing Bitcoin to make further inroads into mainstream finance, following rule changes last year which opened the door to exchange traded funds that track the Bitcoin spot price.

Meanwhile a third driver is the presence of a giant Bitcoin buyer in the market. This jaw-dropping piece by Craig Coben, the former head of European capital markets at Bank of America, explains how MicroStrategy, a software company turned Bitcoin investor, has just announced plans to raise $42 billion in equity and convertible debt and bought $10.2 billion worth of Bitcoin. On top of that, this month, it raised $3bn via a new bond with a zero interest rate that converts into equity at a 55 per cent premium to the current share price.

In effect, people are lending MicroStrategy money at no cost to the company in the hope the shares rise above the conversion price. This is despite the fact they could buy shares from the market. If that all sounds like things are getting out hand, its shareholders are not yet showing much caution. The stock has risen more than 450 per cent this year, and its market cap has rocketed to $90bn.

The company’s playbook is simple. MicroStrategy sells shares and convertible bonds to buy bitcoin. The purchases help support bitcoin’s price, which lifts MicroStrategy’s stock price. Then MicroStrategy sells more shares and convertibles off the higher price to buy more bitcoin. Wash, rinse, repeat.

For those with long memories, MicroStrategy’s return to the headlines may prompt a sense of deja vu. As Coben notes:

A quarter of a century ago, MicroStrategy was one of the darlings of the dotcom bubble, with Super Bowl ads, a stratospheric stock price, and a co-founder, Michael Saylor, who made claims like: “Our software is going to become so ubiquitous, so essential, that if it stops working, there will be riots.” Then in March 2000, reality hit. MicroStrategy restated its earnings, the stock price nosedived from $333 to $0.42 eventually, and the Securities and Exchange Commission came knocking. Saylor and two colleagues later settled a case from the SEC involving hefty fines and disgorgements. The men did not admit the allegations.

This time around, Saylor is no less bullish. He has publicly predicted bitcoin will soar to $13mn by 2045. That would make MicroStrategy’s current stash of bitcoin worth a mind-blowing $4.3tn. A giant ponzi scheme or the investment of the century? I’ll leave it to you to decide.

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5. Angela’s Ashes

Angela Merkel arrives in London this week to promote her book at an event at the Royal Festival Hall. It is fair to say that in the short time since she left office in 2021, her record looks increasingly tarnished. I have never met her but I did get to know many of her closest advisers and ministerial colleagues. I used to think that she was an effective chancellor of Europe but a poor chancellor of Germany. But even this verdict looks too generous now in the light of the position in which Germany and Europe finds itself in the wake of Russia’s invasion of Ukraine.

What lies behind this legacy of failures? This intriguing review of her book by Timothy Garton Ash in the Times Literary Supplement, which he has shared on Substack, suggests that part of the answer can be traced to the first 35 years of her life spent living in communist East Germany. That made her an outsider in German politics, ruthless enough to climb to the top but never strong enough to take on the powerful vested interests of West German business and politics. It also, says Garton Ash, left her with a fear and fascination of Russia that allowed East European men such as Orban and Putin to run rings around her.

It’s an interesting thesis and highly readable piece (unlike, apparently, Merkel’s book beyond the first 100 pages which describes her East German childhood). As Garton Ash says, her career was indeed a triumph and a tragedy.