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Macroeconomic & Geopolitical

How Europe Took a Knife to a Gunfight

1 July 2019 - 3 min read

The continent has made remarkable progress... but its economic interests remain vulnerable in a world that once again favors a sharp elbow over a memorandum of understanding.

The Challenge of Life Caught Between America & China

If Washington and Beijing are indeed headed to a temporary truce over tariff levels, they are also gearing up for a much broader battle across a range of increasingly interwoven political, diplomatic and security issues. Tariffs, technology, North Korea and human rights are all on the table, and Europe finds itself increasingly as a bystander amid the mounting tensions.

The continent has made remarkable progress towards integrating markets and sharing sovereignty, but its economic interests remain vulnerable in a world that once again favors a sharp elbow over a Memorandum of Understanding. Investors eyeing Europe’s long term growth prospects will need to see more of a strategy to avoid collateral damage from the crossfire between Washington and Beijing.

"The continent has made remarkable progress…but its economic interests remain vulnerable in a world that once again favors a sharp elbow over a memorandum of understanding."

This will get increasingly tricky.

Europe welcomes China’s rising levels of investment but worries about the attached strings. European Union resolutions on Chinese activity in the South China Seas or human rights practices have been diluted by Slovenia, Hungary and Greece, which have been wary of jeopardizing important Chinese inflows. Beijing’s investments in advanced European technology raise concerns about their use for military purposes, too.

To the West, there are troubling winds from Washington. While the EU emerged under American protection during the Cold War, the increasingly harsh rhetoric from the Trump Administration on trade and defense budgets has back-footed European leaders. Meanwhile, U.S. sanctions on Iran have forced Europeans to abandon their preferred strategy and looming measures against the Nord Stream 2 pipeline that will expand supplies of Russian gas, which now foreshadows more confrontation.

In the showdown over the purchase of advanced telecommunications equipment from China’s Huawei, European governments are being pressed to declare their loyalties. If it is still unthinkable that they will side with China against the United States, it has also become increasingly difficult for them to side with President Trump on much of anything.

U.S. & CHINA DIRECT INVESTMENT INTO THE EURO AREA.Source: Eurostat, Bloomberg, Haver. As of December 31, 2018

Source: Eurostat, Bloomberg, Haver. As of December 31, 2018

Without a coherent foreign policy or an independent defense pillar, Europe doesn’t have the cross-leverage to protect its interests. Its economic influence is limited, too. The EU’s exports top 45% of GDP, which makes more tariffs or trade barriers especially harmful. Moreover, European firms don’t want to unilaterally forego either the latest American or Chinese technology.

Bruegel, the Brussels-based think tank, has offered a long list of suggestions to bolster Europe’s slender tools that include:

  • Empowering the EU’s chief foreign policy representative to block competition policy decisions when the loss of a continental champion might harm security.
  • Designing a mechanism to scuttle investment deals that raise security concerns.
  • Boosting the international role of the euro by deepening European capital markets, opening swap lines between the European Central Bank and its key counterparts and creating a euro-area “safe asset.”
  • Enhancing the enforcement of European economic sanctions.
  • Establishing a super-committee of European commissioners to help reinforce the EU’s “economic sovereignty.”

This is creative thinking but hardly a quick solution. Careful readers will have noticed the explosive idea around a European “safe asset,” which will not see the light of day – at least until the next crisis pushes Europe to the brink. They will also understand that even the most substantive of these ideas demand a more coherent approach to foreign policy among member states. Even without Britain, the remaining 27 will have a hard time.

Europe is actually far more sturdy and resilient to shocks than the operatic headlines often suggest, but the long-term vulnerabilities to growth and investment are real.

Especially unsettling is the sight of European leaders convening once again this weekend to arm-wrestle over the nationality of the next presidents of the European Commission and the European Central Bank. Any remaining bandwidth will go to stories of Boris Johnson and Italian public spending rather than protecting Europe’s long-term economic interests.

This means that strategic investors will have to think hard about any long-term commitment to a European firm that may find itself the victim of an American financial sanction, a state-subsidized Chinese rival or a technology supply chain that will increasingly force a binary choice between two sides.

European governments have neither the focus, the tools nor the leverage to offer much protection on what increasingly promises to be a bumpy ride for the global trading system.

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