Perhaps it is fitting that this report is being published just before November 11, Remembrance Day, the day commemorating the end of World War I. It was on the 11th hour of the 11th day of the 11th month the guns fell silent.
Lest we forget the sacrifices of many and the terrible carnage of both World Wars.
As a reminder, it was the American-led geopolitical architecture in the wake of World War II, backed by an American nuclear umbrella, which contained the Soviet Union and ensured no major wars erupted after 1945. Now Trump’s America First isolationist policies are dismantling U.S. security guarantees and the possible removal of the nuclear umbrella. How U.S. allies react from the viewpoint of foreign and economic policy will be of enormous consequence for the world for the next generation.
A major issue in the current geopolitical environment is the Russo-Ukraine War. As Trump has shown a high degree of antipathy to NATO, Europe is becoming increasingly alone. How the EU reacts to U.S. isolationism and Ukraine will be of utmost importance to the outlook for Europe.
Here are the bull and bear cases.
Growth in unexpected places
On the surface, the record of EU growth looks weak. Beneath the surface, however, growth is characterized by subpar growth in core Europe and surprising growth in the periphery.
As the accompanying chart shows, GDP per capita in Germany and France were flat since the COVID peak in 2019. However, there are some surprises. GDP in Greece has stabilized since its crisis and has exhibited strong growth since 2019. One standout is Poland, whose per-capita GDP is rapidly catching up to the rest of the EU. Other former East bloc economies such as Czechia (not shown), are also showing strong signs of growth.
Another EU growth star has been Spain, which is set to become one of the fastest-growing advanced economies.
By contrast, Germany has become the sick man of Europe. Its competitive advantages of using cheap Russian energy to export manufactured goods to the rest of the world broke with the onset of the Russo-Ukraine War. In addition, Chinese EVs have become a serious global threat to German and European auto production.
But there is hope. Germany ran out of money to support Ukraine, which created a clash between Chancellor Scholz and Finance Minister Lindner, an FDP partner who believes in the fiscal “debt brake” on fiscal spending. Scholz fired Lindner, which collapsed the government and sets up for probable elections in January.
Germany has the fiscal room to spend, stimulate its economy, fund its share of the Draghi plan for European competitiveness (see The Slow March to Fiscal Dominance), support Ukraine and the European security situation.
In the wake of Trump’s probable disengagement from Ukraine, there have been calls within the EU to assume greater responsibility for its security and 3% of GDP spending on the military, which is in excess of the 2% NATO guideline. The GDP of the EU dwarfs the GDP of Russia, whose economy is about the size of Italy. In theory, this could be a wake-up call for Europe, both from the framework of regional security and growth outlook.
The outlook for Ukraine isn’t totally bleak. Trump promised to end the war within 24 hours, which hasn’t happened yet. But several trial balloons have been floated to end the conflict. Vice President Elect J.D. Vance has proposed freezing the conflict along current lines, the establishment of a de-militarized zone and a promise for Ukraine not to join NATO for 20 years. In return, the U.S. would supply Ukraine with weapons to deter future conflict.
Another, advanced by former Trump Secretary of State Mike Pompeo, focuses on enhanced military and financial support. Another trial balloon floated among Europe’s support of Ukraine calls for the lend-lease of weapons to Ukraine. Kyiv would buy U.S. weaponry, financed by the interest from frozen Russian assets. Such an approach would appeal to the transactional Trump, who can walk away with a win-win, by touting that the U.S. is supporting American manufacturing by selling weapons to Ukraine at no cost to itself.
That’s the hopeful case for Europe.
Party now, pay later
On the other hand, Trump may try to exact too high a price for Europe for the avoidance of tariffs and support for Ukraine. At a minimum, Trump will demand defense spending at 2% of GDP, plus an alignment with the U.S. on its hardline policies against Beijing.
The easy commercial path would be to turn away from the U.S. and pivot toward a closer trading relationship with China. Part of the pivot would involve reaching an accommodation with Putin for an interim peace agreement. Despite all the rhetoric about Russian sanctions, Robin Brooks has demonstrated how German exports to Russia-adjacent countries skyrocketed after the onset of war for transhipment to Russia.
Brooks also reported the consensus from European-based attendees at the recent IMF and World Bank meetings in Washington, D.C. that an end to the Russo-Ukraine War, even if it involved forced Ukrainian capitulation, would represent an end to uncertainty, and therefore bullish for the EU.
The longer-term price is a Ukrainian refugee crisis in Europe, and a severe test of NATO and the sovereignty of the Baltic States of Estonia, Latvia and Lithuania, particularly in light of probable U.S. disengagement from NATO. Undoubtedly, China will be watching the situation carefully for clues of how the West may react to an invasion of Taiwan.
Party now, pay later.
Investment conclusions
Europe is one of the three major trade blocs of the global economy, along with the U.S. and China. The probable withdrawal of U.S. security guarantees will be a paradigm shift in the post-World War II geopolitical architecture of the world. How it aligns itself in the coming years would have a seismic effect on its foreign and trade policy that could last for generations.
While the European growth outlook may appear anemic, investors who seek European equity exposure should consider peripheral Europe as sources of growth.
In addition, investors may benefit from exposure to European financials, which are outperforming based on tailwinds from a trend of global central bank easing.
I doubt that Russia would agree to freezing the conflict or to any solution that is not permanent or allows rebuilding Ukraine’s military. The West has run out of weapons and munitions and Ukraine has run out of soldiers. The eventual peace agreement will be on Russia’s terms. One has to go beyond the western mainstream media to understand the realities.