Merlin Weekly Macro: ‘America First’ leaves Europe floundering

The Trumpian organised chaos continues, prosecuted eagerly by his attack dogs JD Vance, the Vice President, and Marco Rubio, the Secretary of State. Giving a running commentary on world events, particularly with tariffs which can seemingly be imposed and rescinded within a matter of hours, is counterproductive.

Much more important is to stand back from the noise and distil the extent to which a new order is being forged real-time right in front of us, live-streamed on to our phones and tablets.

MAGA: no joke

If anyone still fails to understand ‘Make America Great Again’ and ‘A-M-E-R-I-C-A-F-I-R-S-T’, Trump’s State of the Union address spelled it out very clearly: “We are going to forge the freest, most advanced, most dynamic and most dominant civilisation ever to exist on the face of this earth”. It is brutally simple: America will dominate the world. That is his plan.

Does it sound familiar? It should do because we have described it in these columns often enough: in its own image, China also is intent on forging a New World Order: the China Dream, with Chinese Communism as the apex, alpha ideology. It too is an explicit aim, to be achieved by 2049, the centenary of the founding of the Chinese Communist Party (CCP); it is enshrined in General Secretary Xi Jinping’s Thoughts, adopted in October 2017 after he was officially anointed ‘Core’ (‘emperor’ would be the nearest western synonym) by the CCP. Xi aims to achieve it with his friend Vladimir Putin; he said so explicitly as they bade each other farewell on March 22 2023 after the Chinese leader’s visit to Moscow.

Like two Sumo wrestlers circling each other in the ring, this is potentially a veritable clash of the titans. While Trump and the Republicans were giving it the full YOO-ESS-AY! and woopee-do in Washington, in Beijing at the spring meeting of the CCP, Xi’s icy calm response to Trump’s latest tariffs was bring it on: ‘we are ready for any type of war with the US’.

A seismic shift in geostrategy

The colonial and neo-imperialistic overtones are also self-evident. China, through its One Belt One Road and String of Pearls strategic global projects, including the recovery of Taiwan; Russia through the appropriation of Ukraine and the creation of a militarily and politically sterile buffer zone in eastern Europe separating the Motherland from both the EU and NATO and what Putin sees as their subversive threats to his authority. As for the US, Trump reiterated his expansionist ambitions to own Greenland (‘we’ll get it, one way or another we’ll get hold of it, it’ll be ours’), Canada (he’s not joking about the ‘51^st State’, going so far as to refer to outgoing Prime Minister Trudeau as ‘Governor’ Trudeau), and the Panama Canal where this week the investment giant BlackRock has taken a leaf out of China’s book and acquired significant stakes in key Panamanian ports. China and the US are fierce rivals in the leadership of key technologies and strategic industries, notably AI/Digital software, tech hardware, defence, automotive, aerospace and pharma. Control of commodities and rare earth minerals of all varieties is key too.

The significant difference between the autocracies and the US when it comes to projecting and protecting strategic ambition? The robustness of the US Constitution and the rule that no President gets more than two terms, and the natural democratic electoral cycle. But Trump has an answer to that too: step forward his Vice President, JD Vance. With his high-level and fully endorsed belligerent interventions as Trump’s protégé, whether at the Munich Security Conference, or in the very deliberate political assassination of President Zelensky in the Oval Office, or his reference to ‘random countries who have not been to war in 30 or 40 years’, through Vance Trump is paving the way to secure his legacy beyond into the 2030s. The Republican presidential caucuses in 2028 might have different ideas; time will tell. One can only assume the Democrats have some cunning plan that is not immediately evident to anybody else, because while Trump is re-shaping at least his half of the world, publicly they are almost completely missing in action as an effective political opposition.

Europe: scrambling to find its bathing suit

But while America, China and Russia are brimming with confidence and have a very clear idea of their directions and trajectories, Europe has been caught floundering. To use Warren Buffet’s well-worn phrase, it has been ‘caught swimming naked when the tide has gone out’. Its inadequacy out of the water and in the icy blast of a chill wind has been embarrassingly obvious.

This week’s second European emergency security summit in ten days has galvanised a response: a €150bn loan package from the EU’s central budget; plus a further €650bn potentially to be freed up by relaxation of the EU’s Economic Stability Mechanism. This currently insists members’ maximum national deficits should not exceed 3% of their GDP and national government borrowings should be no greater than 60% of GDP. That all major EU economies are already substantially in breach of the ESM limits, even before the new defence arrangements, only accentuates the parlous state of the EU’s finances.

The exception is Germany; there the debt brake law put in place after the Global Financial Crisis forbids a budget with a deficit greater than 0.35% of GDP unless ‘in emergency’. The new Chancellor elect, Friedrich Merz, has already proposed that Germany will define the defence spending programme as such an emergency, it will breach the debt brake thus paving the way for €500bn of investment on both defence and infrastructure (it will be put to the Bundestag where the defence provision amendment to the debt-brake law will need a two-thirds majority to pass). The reality is that unlike the pandemic which was a genuine emergency, Germany’s current predicament is no sudden emergency at all: it was a visibly slow-burning fuse that was lit by the Merkel government which has rapidly accelerated from flash to bang. It was Merkel who mortgaged the economy to Russia as the principal supplier of gas, while closing all Germany’s nuclear facilities and accelerating the closure of coal-fired power stations; she followed previous administrations who cut back significantly on defence spending to fund social costs, to which she added financial aid for the cost of reunification. It is with no sense of irony that it is today’s President of the European Commission, Ursula von der Leyen, leading the charge on EU defence spending; as Merkel’s defence minister, she fully supported Germany’s strategy and it was on her watch that German soldiers were photographed taking part in NATO military exercises armed with broomsticks for lack of rifles.

So what does an extra €800bn, or approximately $860 billion represent? In 2024, official returns show that the EU’s NATO members spent $360.7 billion on defence, 2.1% of the EU’s GDP. All NATO member states had already agreed in principle that defence spending would need to rise to 3% of GDP; it was to be endorsed at the 2025 June summit. The commitment has been accelerated in the light of events. At constant prices, that near-50% uplift in EU defence budgets is the equivalent of $180 billion. The sum just agreed in this week’s summit meets approximately four-and-three-quarter years’ worth of that additional expenditure beyond the aggregate sum of existing national defence budgets. The reality is that after bleeding defence for three decades and taking the ‘peace dividend’, this is not so much expansionary spend to meet the new threat, as a partial catch-up to what Europe’s armed forces should have been had countries met NATO’s minimum bar of 2% all along.

Markets shoot first and ask questions later

The most extreme reaction this week in government bond yields seen in years betrays the markets’ fears about the risks posed by the prospective debt burden. The EU is haemorrhaging cash. In no more than a week, the key 10-Year German government bond yield has risen from 2.38% to 2.83% at the time of writing, despite a new quarter point cut in eurozone interest rates by the ECB; Germany’s 30-year government bonds now trade on a yield of 3.1%, the highest level since 2011, having been 2.6% a week ago. It may prove an over-reaction but the implications for Germany’s interest bill are obvious, especially applied to what is likely to be much higher national borrowings.

What should be unarguable is the need to abandon the embedded, enduring and lazy Keynesian orthodoxy that pervades most major western economies. It is that myopic collusion which has given rise to historically high and unsustainable national deficits and debt levels, as well as debilitating tax burdens. It needs to be replaced with fiscal discipline and prudence based on wholesale reform of public sector expenditure, including major reform of defence procurement. Otherwise, western governments are simply swapping defence risk for financial risk; one is physical, the other economic but in their own way both have the potential to be existential.

Structurally flawed, strategically adrift

Therein lies the EU’s major structural flaw: it is a less than quarter-baked confection of what needs to be a homogenous economic system. It has neither fiscal union nor debt union to complement monetary union (and even that is incomplete with 7 countries as members of the Union but not of the eurozone). Fiscal union cannot be successfully achieved without political union as a prerequisite; taxation without representation is profoundly undemocratic. Yet the concept of the shared burden is as fundamental to the new security package in Europe as it is to the whole of NATO. While the Americans have been justifiably annoyed at underwriting the cost of defending ‘Europe’ without the Europeans pulling their weight, the same problem now applies within Europe: in this regional mutual protection society, the financial heavy lifting will in reality fall on the shoulders of the biggest economies to protect their smaller neighbours. It becomes a political challenge to persuade the increasingly nationalistic electorates in Germany, France, Italy and Spain that they should be on the hook not only paying for their own national defence but that of others in some cases geographically half a continent away. Playing piggy-in-the-middle, the UK has the same challenge about spending.  

The EU wants to play with the grown-ups: it sees itself up there with the US and China as one of the three Great Powers. But the very fact of it not being a nation state, merely a federation of 27 countries only 20 of which have a single currency, precludes it from doing so. It has just been very publicly dismissed and demeaned as irrelevant by both Trump and Russia. The EU still suffers the Ghost Busters’ conundrum: “if there’s something strange in the neighbourhood, who you gonna call?” Who indeed.

To Vance’s ‘enemy within’ jibe last month in Munich, voters are not literally disenfranchised: they have the facility to vote in EU elections. However, the significant democratic deficit which is tantamount to disenfranchisement arises from the act of electing a parliament with no direct constituency representation and which makes almost no difference to pan-EU policy, how it is developed or how it is implemented. By extension voters in EU elections have very little if any say over how policy affects their own lives. Vox pop counts for virtually nothing.

This fundamental democratic deficit at the heart of the EU will not be overcome without political union and full electoral reform. Effective disenfranchisement leads to political instability and polarisation, the result of which is rising ‘populism’. Whether it is to the political right or left is irrelevant.

Directly linked in the defence debate is Zelensky’s call for a ‘European army’. This too is not new: over the past twenty years several EU leaders have made the same demand. Armed forces are one of the essential trappings of the nation state. As we have established, the EU is not one. A fundamental question if an EU or wider European armed force including the UK were to be created: who would control it? On whose authority would it be deployed and go to war, and in pursuit of whose policy and under whose rules of engagement? In a crisis, would everyone even turn up? In line with the Clausewitz dictum that ‘war is merely policy by other means’ this is not a military question; it is entirely political. It goes right to the centre of sovereignty and democratic accountability. Until this foundational principle is explicitly resolved, a centralised armed force is on shaky ground and should be strongly resisted.

Trump and Putin have caused all Europe’s obvious structural shortcomings to be exposed and crystallised very quickly. The EU is a top-heavy, heterogeneous edifice whose foundations are built on sand. Having ignored the gaping chasms in its governance for more than quarter of a century, the EU has only itself to blame. As to whether it is capable of successfully integrating and completing full Union from here remains to be seen. The political challenge is as formidable as it is unavoidable.

Parting shot: just who is having their chain pulled here?

As the alignment of the geostrategic stars is rapidly re-ordered, with regard to Europe and Ukraine we might ask ourselves who is really in control? Trump thinks he is. Or is the reality that it is Putin, the arch manipulator?

It is a year ago that Donald Trump emitted his infamous outburst about his future NATO allies: he would encourage Russia to do “whatever the hell they want” to any delinquent NATO country; “you got to pay, you got to pay your bills” he told them. Now he is President and by default leader of the Free World, what is his challenge to Russia today? Is it, “go ahead, punk, make my day” or is it “go ahead, President Putin, be my guest”?

All the evidence still points to the latter. The ball is firmly in Europe, the UK and Canada’s court to make sure it is the former. Europe is love/one down after the first set but catching up in the second; it needs to win both that and the third set (the implementation of effective defence spending---delivering bang for buck) to remain in the competition. 

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