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Alright, we need to talk about Europe today. We live in a world where inequality is worsening, and at the heart of this problem is reckless government spending. When governments spend money without caution, it causes major issues, leading to a massive surge in asset prices while the economy’s core fundamentals deteriorate.
While the US is trying to rein in its deficit, the Eurozone has emerged as a new major spender. Over the past week, Europe has taken some bold actions, and the markets are reacting negatively. The German bond market is experiencing its steepest decline since the fall of the Berlin Wall, with yields nearing 3%. Investors are now demanding higher returns, signaling a lack of trust in the German government. This is disastrous for an economy on the brink of collapse, especially one accustomed to near-zero interest rates.
So, what triggered this? Well, it’s a massive shock to the system. On top of that, there are concerns about NATO and defense spending. The question arose as to whether the US would defend NATO members who aren’t meeting their financial obligations. The answer was clear: if countries aren’t paying their fair share, the US won't defend them. This is a huge statement, indicating that the US may not honor NATO’s Article 5 commitment to defend member nations in case of attack.
For countries like Germany and other European nations, this is a wake-up call. The US may no longer be their safety net, and now, more than ever, their own economies will need to step up. The incoming German Chancellor is already moving forward with plans to establish a massive 500 billion Euro infrastructure fund, plus a special defense fund. Germany, traditionally fiscally responsible, is prepared to break its debt limits to rearm. In fact, Germany has one of the lowest debt levels among the major G7 nations, especially when compared to the United States.
The Rise of Europe’s War Economy
Before Trump took office, Germany's debt-to-GDP ratio was expected to drop from 64% to 58%. In contrast, the US was predicted to see its debt climb to 134%, and Japan’s debt level was a staggering 250%. However, the situation has completely changed. Now, Germany, the UK, and much of Europe are facing an existential crisis. They fear that Russia might invade the EU, while the US is stepping back from its traditional role as their protector. As a result, Europe's reaction has been to rapidly raise funds to rebuild their military industries.
Since the end of World War II, Europe has heavily relied on the US for collective defense. But with Trump’s America no longer willing to foot the bill, Europe is in a precarious situation. Without US support, their defenses could crumble in a matter of weeks. This might sound dramatic, but it reflects the desperation of the moment. If the EU goes toe-to-toe with Russia, its stockpiles of resources could run out in days, and rearming would take years. Europe’s military forces are fragmented and undersized, and without US backing, they would stand no chance against a unified Russian army. This is similar to what broke Napoleon during his campaign in Russia—supply chains were fractured, and the extended war in harsh winter conditions led to his downfall. Europe is now facing the same challenge, but with an even bigger issue: they don’t have enough equipment to defend themselves.
To address this, Europe is scrambling to rapidly rearm. Normally, the EU would turn to the US for weapons, but given the strained relationship with Trump and a looming trade war, Europe is determined to reduce its reliance on the US. To make this happen, European leaders are ready to unleash a massive spending plan. The European Commission’s defense plan, called Rearm Europe, aims to mobilize nearly 800 billion euros to build a safer and more resilient Europe. This initiative is poised to make defense companies extremely wealthy, as the defense sector has already seen a 60% surge this year, with major companies like BAE and Rymetal benefiting.
However, this massive expenditure of 800 billion euros is not without its challenges. Unlike the US, the EU doesn’t control the global reserve currency, so borrowing this amount will place significant strain on their economies. There's no turning back now, though, as the EU has pledged unwavering support for Ukraine, and much of the rearming plan is focused on speeding up weapon deliveries. This has already driven up stocks in defense companies, with EU stocks outperforming the S&P 500 this year.
Despite this growth in the defense sector, the German bond market is collapsing, and yields are rising—signaling broader economic instability. This is due to a fundamental issue: Europe lacks the raw materials necessary for efficient rearmament. Investors see the truth: Europe will need to borrow far more than 800 billion euros to rebuild its military. In reality, it could take trillions. Even if Europe spends a trillion dollars, it will likely receive only a fraction of that in value due to inefficiencies in production and energy costs.
Since February, German power prices have exceeded crisis levels from 2022 and 2023, and the country is still paying high prices for energy inputs. Comparatively, production costs in Russia, China, and the US are far lower than in Europe. The spending to rearm Europe will thus be inefficient, much like the tariffs imposed by Trump, which made industrial inputs more expensive. Europe also faces a shortage of cheap energy sources. Its decision to avoid buying affordable Russian gas means it now has to import costly LNG from the US. Until the EU addresses this issue, it will continue to borrow money endlessly, unable to fill the economic black hole with just 800 billion euros.
Melt-Up or Crash?
Europe is in a tough spot. A global recession seems likely, and as we’ve noted, the US GDP is expected to drop in Q1 this year, with a 2.4% contraction forecasted. The Federal Reserve's warning is serious, and it can’t be ignored. US consumption is slowing, and the ongoing trade war is only adding to the challenges. For Europe, this spells trouble since the US is their biggest trading partner. If the US economy falters, Europe’s trade surplus could shrink significantly.
Now, how does Brussels plan to fund its military buildup? They’ll have to borrow more from the open market, which would drive yields even higher, or raise taxes, further damaging their own consumption. So, no matter how you look at it, Europe is in a precarious position. It’s like trying to rearm with one hand tied behind their back while hopping on one leg—things aren’t looking good.
To make matters worse, brutal tariffs are on the horizon for the Eurozone. Trump has pledged a 25% tariff on EU exports, and Europe’s own trade policies aren’t helping matters. They impose VAT taxes of around 20%, along with other tariffs, and this could result in reciprocal tariffs from the US. With Trump’s tough stance on trade, many EU economies are at risk of slipping into recession. When the entire world is in a downturn, it becomes incredibly difficult to borrow money at affordable rates.
In a typical recession, bond yields would fall, but in Europe’s case, they could skyrocket as they try to rearm, which is horribly timed. Now, could Trump backtrack and offer Europe an exemption? Sure, it’s possible. But even if Europe avoids the 25% tariff, they’ll still face retaliatory measures. Given Europe’s reliance on value-added taxes, the EU could end up facing tariffs averaging over 177%. The outlook doesn’t look good.
Trump’s agenda is directly at odds with Europe’s plans. While Europe wants to rebuild its industrial base, particularly for defense, Trump is focused on restoring American industries. Europe finds itself stuck between a rock and a hard place. It’s a bizarre situation. Macron is convinced Russia will attack, while Russia mocks him, calling him “Macron Micron,” which, frankly, is a bit humorous. We’ve now reached a point of nuclear threats, and Europe seems poised to ramp up its defense spending without fully considering the consequences.
If this escalates, we could see more inequality and inefficient allocation of funds, with much of the money funneled into the defense sector. If things get bad enough, Brussels might demand higher contributions from member states. But if investors refuse to lend money at affordable rates, countries will have no choice but to raise taxes—imagine doing that during a recession. The outcome doesn’t look promising.
What do you think? How much is Europe really willing to spend, and can they successfully rearm themselves? Let me know in the comments.
Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.
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