The Return of Imperialism plus other global revolutions

Thoughts on Rachel Reeves's lucky break, what not to expect from the German election, will Trump's Russia pressure tactics work, what's at stake in Greenland and is China winning the AI race

Photo by Visit Greenland on Unsplash

A big welcome to new subscribers and particular thanks to all those who have recently become paid subscribers. Your support is hugely appreciated. This was supposed to have been a shorter newsletter but it got longer as there were a few topics I was keen to discuss. The post is free to read so please do share with others you think might be interested and encourage them to subscribe. As always, I am keen to hear your thoughts so do leave comments. On a separate note, I will be in Brussels the week after next where I am very much looking forward to moderating a panel at the UK-EU Forum annual conference (register here). If any readers are in Brussels and would like to meet, do get in touch!

• Reeves’s Reset: The joy of higher gilt yields

• European Growth: Don’t count on Germany

• Sanctioning Russia: Bear squeeze

• Why Greenland? The new Age of Empire

• Is China Winning? Stargate versus DeepMind

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1. Reeves’s Reset

There is an intriguing line in Tim Shipman’s “Inside Number 11” analysis in the Sunday Times today on Rachel Reeves’s efforts to reset the government’s economic narrative after a sharp rise in gilt yields at the beginning of the year. Having spent much of her first seven months in the job highlighting her dire economic inheritance, the chancellor has now switched to sales mode. Last week she was in Davos, trying to extol Britain’s prospects to global business leaders and investors; next week she will set out her growth strategy in a much-anticipated speech. In this task, she has had assistance from an unlikely quarter:

In the Treasury’s telling, the market panic early this month, when the cost of government borrowing soared above the levels under Liz Truss, was a useful sword of Damocles that Reeves can now wield over her cabinet colleagues during the upcoming public spending review. “A lot of that coverage was actually incredibly helpful for us,” an ally said. “Because we already knew the argument we wanted to make: further and faster.”

On the face of it, it takes some chutzpah to claim that a rise in bond yields that throws your budget calculations into doubt and may force you into emergency fiscal tightening to stay within your fiscal rules is actually good news. On the other hand, I think Reeves has a point. As noted last week, Reeves’s political and media opponents over-played their hands with their attempts to claim that the rise in bond yields was a delayed market reaction to her budget. Not for the first time, it appeared as if some parts of the media were actively trying to trigger a Liz Truss moment the hope of destabilising a Labour government.

Yet over the past week, largely unreported, gilt yields have fallen back close to where they were at the start of the year, tracking US Treasury yields on the way down as they did on the way up. That makes a mockery of the idea that the market reaction was a response to a relatively modest rise in business taxes and hike in the minimum wage that do not in any case take effect until April. But the pressure on the budget does give Reeves a chance to shift the focus back to what is supposed to be the government’s primary mission: to revive growth.

The evidence of the past week suggests the government means business. Sir Keir Starmer’s announcement last week of plans to overhaul the judicial review process that has allowed infrastructure projects to be held up for years by endless legal challenges. Reeves has indicated that the government is poised to give the green light to expansions of Heathrow and Gatwick airports. The government’s decision to replace the chairman of the Competition and Market authority with a former Amazon executive suggests a shift in the regulator’s focus from expanding consumer choice to maximising investment.

We will have to wait and see what else Reeves comes up with in her speech. What is certain is that any growth strategy will bring the government into conflict with powerful vested interests, not least NIMBY opponents of new infrastructure and house-building. But the reason why a Labour government with a large majority was so clearly in the national interest was to deliver desperately-needed supply side reforms that had eluded the Tories for the previous 14 years. If the effect of the recent rise in bond yields has been to embolden a government whose hallmark until now has been excessive timidity, so much the better.

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2. Don’t Count on Germany

One thing that is almost certain to happen next week is that the European Central Bank will cut interest rates by another quarter of a percentage point. Not that anyone other than market insiders will take much notice. There is a broad consensus that the recent slight rise in inflation, largely driven by higher energy costs, is not enough to offset the case for loosening monetary policy for an economy hit by a weakening growth outlook. Indeed, the main point of argument among economists is whether, other things being equal, eurozone interest rates ultimately need to be cut from 3 percent to 2 percent or 1.5 percent.

But, of course, other things are not equal. Any forecasts for what might happen to the eurozone economy over the rest of this year and beyond are highly conditional upon assumptions about what Donald Trump may decide to do on tariffs, what happens to the US budget deficit, US interest rates and the outlook for the dollar. The extent to which Europe’s financial fortunes are now entirely beholden to US policy was brought home to me the other day when I attended a briefing on European equity strategy by analysts at Bank of America. During an hour of presentation, possible European policy decisions were barely mentioned.

When I asked the analysts what if anything European policymakers might do that might have any bearing on the outlook for European assets, the only thing that anyone could really think might move the needle was for Germany to lift its debt break. Indeed, the question of whether the next government will reform this legacy of crisis-era German fiscal bravado which limits Berlin from running a deficit of more than 0.35 percent of GDP in any year has become the central point of interest for economists ahead of the election that will be held on February 23.

As The Economist notes this week, there is an overwhelming consensus among economists and policymakers that the debt brake needs to be lifted. That includes Olaf Scholz, the current chancellor, the Bundesbank, the IMF, the OECD, Germany’s biggest trade union, its state-appointed council of economic experts and even Angela Merkel, who was chancellor when it was introduced.

Germany faces huge spending pressures in the coming years, including hundreds of billions of euros for infrastructure, decarbonisation, education. It will also need to spend an extra €47 billion a year (1.1 percent of GDP) on defence if it is to meet the 3 percent of GDP target that Trump is reported to be demanding. And with a debt to GDP ratio of just 64 percent, it has plenty of fiscal headroom to increase borrowing. What’s more, voters seem to agree, says The Economist:

A forthcoming opinion poll conducted for the German Council on Foreign Relations (DGAP) finds that a majority of Germans want reform of the debt brake to allow for higher investment.

Nonetheless, investors - and German citizens - should not get their hopes up too much, according to Goldman Sachs. Based on an analysis of the election manifestos, it outlines three possible scenarios:

• Limited Fiscal Upside (50% probability)": this assumes the creation of a new €160 billion special defence fund outside the debt brake plus the adoption of a golden rule to allow a modest increase in investment spending. This would lift growth by a mere 0.05 percentage points this year and 0.1 ppt next year.

• Substantial Fiscal Upside (20% probability). this assumes the creation of a much larger special defence fund of €240 billion to allow defence spending to rise to 3% of GDP by 2028 along with a more significant debt brake reform. This could deliver a growth boost of 0.1 percentage point this year and 0.2 percentage points in 2026.

• No fiscal upside (30% probability). This assumes that no constitutional measures are implemented and spending evolves according to the current medium-term fiscal plan, implying no upside relative to current forecasts.

The problem is that both the first two scenarios require a two thirds majority in parliament to deliver changes to the constitution. But while current polls suggest a 60-70 percent likelihood of this being achieved, this alone will not be sufficient to deliver the most ambitious reform. That’s because most of the left-wing parties are opposed to increase defence spending, while the Christian Democratic Union and other conservative parties are opposed to debt brake reform.

Much will therefore depend on the relative strength of the parties in the new parliament as to what compromises can be achieved. Hence the higher probability of the limited upside scenario. Meanwhile Goldman reckons there is a 30 percent chance that the mainstream parties do not get their two thirds majority, leading to political gridlock and no reform at all.

That makes this German election unusual in that what matters from an economic perspective is not just who wins, which seems a foregone conclusion, or even who forms the next government, which is likely to come down to predictable choices, but how well the losers perform, in particular the populist parties on the far right and far left. That makes scenarios such as this, in which Elon Musk beamed into a weekend rally to reiterate his support for the Afd even more disturbing.

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3. Bear Squeeze

Perhaps the biggest positive surprise of Donald Trump’s first week back in office was his unexpected belligerence towards Russia. For months, Europeans have worried that the incoming president’s vow to end the Russia-Ukraine war on his first day in office would lead to him trying to pressure Kyiv into a catastrophic surrender. But not only has he pushed back the deadline for making a deal to 100 days or even six months, he has threatened to up the economic pressure on Russia if President Vladimir Putin does not strike a deal:

If we don't make a 'deal', and soon, I have no other choice but to put high levels of Taxes, Tariffs, and Sanctions on anything being sold by Russia to the United States, and various other participating countries."

Several of Trump’s most senior cabinet members, including Marco Rubio, the secretary of state, and Scott Bessent, the acting Treasury secretary, have since reiterated the administrations willingness to hit Russia with extra sanctions. For added measure, Trump also called upon Opec and Saudi Arabia to lift their oil production in a bid to lower oil prices. That, he said, was the surest way to end the war quickly, given the Russian economy’s dependence on oil revenues.

Unfortunately Trump’s threat to increase the economic pressure on Russia is unlikely to yield any quicker or more satisfactory resolution to the conflict. As Alexandra Prokopenko, a Fellow at the Carnegie Russia Eurasia Center and a former staffer at Russia’s central bank, argues in an essay for Foreign Affairs, sanctions are certainly biting and Russia’s war economy is creating huge distortions, as spending on defence fuels inflation while depriving other sectors of resources. But Putin should be able to manage the fallout in the short-term:

Businesses can survive a year of double-digit interest rates on loans if they cancel investments. With $31 billion in the National Wealth Fund, the government should be able to solve, temporarily, the financial problems of corporations it deems “too big to fail”—although it may have only enough cash on hand to throw money at a problem once. The authorities could create a larger financial cushion by issuing war bonds that entrepreneurs and households are obliged to buy. Substantial payouts to soldiers and the broader spike in salaries have also improved standards of living for many Russians, which for now is keeping a lid on public discontent and giving the Kremlin some breathing room.

Sure, next year is likely to be a different story. By 2026, the limits of Russia’s economic model will be impossible to ignore. Inflation, the costs of wartime productions and the structural distortions will push the economy towards a reckoning. But that is a long time during which the West will need to continue to sustain Ukraine both militarily and financially. So far Trump has shown no sign that he is prepared to provide Ukraine with that kind of support. Indeed, Kyiv anxiously trying to find out whether the new administration’s moratorium on disbursements of US aid applies to Ukraine.

Meanwhile Trump has yet to spell out what he thinks would be a reasonable settlement to the conflict, or what security guarantees he would be prepared to offer Ukraine. Until he does, Europeans are right to remain nervous.

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4. Why Greenland?

So it seems that Trump really is serious about annexing Greenland. The Financial Times reports that the president held a “fiery” call with Danish prime minister Mette Frederiksen last week in which he became aggressive and confrontational when told that Greenland was not for sale:

“It was horrendous,” said one of the people. Another added: “He was very firm. It was a cold shower. Before, it was hard to take it seriously. But I do think it is serious, and potentially very dangerous.”

One puzzle is why exactly does Trump want Greenland so badly? The most frequent argument is that America needs it for national security reasons. As Arctic sea ice melts, it is opening up new sea lanes that China and Russia may seek to control and turning the region into a new arena of geopolitical competition. Yet this is unconvincing, as Daniel Fried, a fellow at the Atlantic Council and former US ambassador to Poland, notes:

Greenland indeed has strategic significance, which is why the United States sought and obtained extensive defense cooperation and basing rights there in 1951, through the Defense of Greenland Agreement. If that agreement, and subsequent supplemental agreements, are not working or are inadequate, Trump can make that case. But he has not done so. Instead, he spoke at the January 7 press conference as if those agreements, and the existing US base in Greenland, do not exist.

Others argue that Trump wants the island for its rich mineral resources. But this makes little sense either, as Javier Blas points out for Bloomberg.

A 2023 Danish geological survey identified at least 50 locations in Greenland with mineral potential. Of them, more than half are north of the Arctic Circle making their exploitation very hard and expensive, if not impossible. A handful, however, are in the ice-free southern tip of Greenland, opening the door to development. But most of these are small.

Could the price of these critical minerals ever rise to a level that made extracting the larger reserves in the Arctic commercially worthwhile? That seems unlikely:

According to the US Geological Survey, considered an authority in the field, the island contains 1.5 million tons. That puts Greenland in the world’s top 10, but well behind the US itself, as well as China, Brazil, Vietnam, India and Australia. Very likely, mining for rare earths in all of those countries would be easier and cheaper than in Greenland.

If the US is serious about mineral supply, it has better places to flex its diplomatic muscle. The Democratic Republic of Congo is, by far, the most important one — home of huge proved reserves of copper and cobalt, two minerals far more important than rare earth elements. So are Chile, Peru, Brazil and Mongolia. Kazakhstan goes into the list too. Sadly none of them is for sale. But neither is Greenland.

It is hard to avoid the conclusion that Trump’s goal is simply to secure his place in the history books as a president who expanded American territory. Indeed, he said as much in his inaugural address. But this 19th century imperialist approach towards Denmark, a NATO ally, risks undermining trust and goodwill and weaken America, as Colin Pascal argues in this column for The Hill:

President Trump’s suggestion that the U.S. might use coercive means to alter conditions in Greenland gets the U.S. nothing it doesn’t already have. At the same time, it puts in jeopardy the hard-earned image of America as a benevolent power and weakens the trust that underpins our alliances.

Lacking trust and operating with weakened alliances, to achieve its ends the U.S. would need to become something it’s never been: A bully on the world stage. This not only sacrifices the moral high ground, but it also leaves America less safe than it’s been for 80 years.

From a European perspective, the situation is even more alarming. As discussed last week, it merely confirms Trump’s disregard for the liberal rules-based order and America’s traditional alliances. Yet this apparent return to might-makes-right world in which rival empires seek to lock up access to resources and control trade routes is one for which the countries of Europe are utterly ill-equipped. Trump is threatening to unleash a trade war against an EU member and NATO ally to seize European territory - and it is not clear what Europe can do about it.

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5. Stargate versus DeepSeek

The emerging battle between rival superpowers for global supremacy will not just be fought over control of territory and resources but over who owns the dominant technology. Two remarkable developments in the field of AI last week gave a foretaste of how that battle might play out.

The first was Donald Trump’s announcement of The Stargate Project, which he called "the largest AI infrastructure project by far in history". Stargate is a $500 billion venture backed by OpenAI, Oracle and Japanese company Softbank whose aim is to ensure that the US continues to dominate the technology in the future. The money, $100 billion of which is supposedly available immediately, will be used to build 20 data centres across America which will be used by OpenAI and which Trump boasted will create 100,000 US jobs.

How much of this will actually happen is an open question. Details of how the Stargate investment will be spent were thin on the ground. A bigger question, delightfully posed by Elon Musk, who has a long-running feud with OpenAI’s Sam Altman, in a series of late night social media posts is whether the Stargate partners can afford to invest $500 billion, as the Washington Post reported:

“They don’t actually have the money,” Musk wrote to his 214 million followers. “SoftBank has well under $10B secured. I have that on good authority.”

“Wrong, as you surely know,” Altman replied. “Want to come visit the first site already under way?”

Regardless of who is right, the Stargate news was somewhat eclipsed just days later by news out of China where DeepSeek, unveiled a new chatbot that can match the capabilities of OpenAI’s ChatGPT and Google’s Gemini with a fraction of the costly semiconductor resources its American rivals need.

DeepSeeks’s achievement threatens to completely upend some of the core assumptions underlying American confidence in its AI leadership. The fact that it was created on cheap poses a profound challenge to the prevailing idea that only the giant US tech companies can afford to make the most advanced AI systems:

The Chinese engineers said they needed only about $6 million in raw computing power to build their new system. That is about 10 times less than the tech giant Meta spent building its latest A.I. technology.

Secondly, the fact that DeepSeek was able to create such a powerful chatbot at all casts doubt on the effectiveness of US efforts to limit Chinese AI development by restricting access to the most advanced chips. DeepSeek says that because of U.S. restrictions, its engineers are forced to do more with a lot less. The company says it used about 2,000 Nvidia chips; tech giants use as many as 16,000. Others think Chinese companies have been stockpiling chips or buying them from smugglers.

But perhaps the most concerning aspect of DeepSeek’s success is what it may mean for the geopolitical competition to dominate the new technology, notes Andrew Ross-Sorkin the New York Times Dealbook:

The company also makes its software open source, meaning anyone around the world can gain access to the underlying code and build products on top of it.

While many in the United States have argued that allowing unfettered access to open-source A.I. software is dangerous, others say the risk is that Chinese open-source products will end up becoming the global default.

That points to what may be the biggest challenge for the Trump administration as it seeks to frame its own AI policy: how to translate technological leadership into global leadership. As Colin Kahl, a former under secretary for defense policy in the Biden administration argues in this recent essay for Foreign Affairs:

Winning the global AI competition will require protecting and increasing the United States’ technological lead. But it also necessitates more active engagement with the nations that will ultimately determine how—and whose—AI is deployed worldwide. Failing to balance both risks a paradoxically grim future in which the United States beats China to the AI frontier, only to cede global leadership of the emerging AI world order to Beijing.

Meanwhile, it goes without saying that Europe is nowhere in this debate. As the EU frets about AI safety, almost certainly with good reason, its own AI Act risks stifling innovation while doing nothing little to counter the potential spread of powerful, potentially even harmful technologies elsewhere. How Europeans gain access to, and benefit from, this technology while protecting themselves against harms and preserving some degree of autonomy is one of the most urgent questions contributing to the continent’s existential crisis.