Europe in Turmoil (A Useless Peace)

(October 14, 2024)

“…with Trump back in the White House, there will likely be an acceleration in the evolution of how many wealthy countries - traditionally US allies - think about their own national security.

The question has been front and center in Europe since the beginning of the war in Ukraine…”

“…Europeans have been spoiled for 30 years after the fall of the Berlin wall by Russia’s relative weakness and America’s global dominance. Policy decisions were simple as there was no trade off between friendship with Russia and military alliance with America.

While US military (and tactical nuclear weapons) stationed in Europe did raise the occasional eyebrow, the benefits - being able to keep defense spending at a minimum - far outweighed the drawbacks. Meanwhile, a constructive relationship with Russia made it possible for Europeans - in particular for Germany - to get low-cost energy.”

Both sides of the equation have changed. Russia’s thaw with Europe proved to be just a blip in history…(and the Ukraine war) has factually ended Europe’s energy ties with Russia. And America under Trump would require European countries to seriously increase their defense capabilities, or risk facing American disengagement.

Public opinions in Europe could respond two different ways. (Accept) Russia’s role in European affairs, or (prepare) to dramatically increase (…) defense budgets.

Either way, building up military capabilities takes time, and as many shrewd commentators have already anticipated, Europe would have a hard time supporting Ukraine on its own if the US decides to turn isolationist. It would have to take increasing risks, exposing its territory to potential Russian retaliation without US protection.

Geopolitical risk can arise from both scenarios. If European countries decide to concertedly rearm, and coordinate expenditures to face the Russian threat, Russia may decide to up the ante and increase provocations. If Europe takes the less confrontational road, and lets Ukraine go, it would create a precedent that would reshape expectations about security in Europe for years to come.

The End of the Transatlantic Alliance

The post-World War II transatlantic alliance, once a cornerstone of the global order, is effectively over. In its place stands a United States focused solely on its own interests and a fragmented, directionless Europe.

While Europeans expected the turn of events, they appear to have been surprised by the speed and force - as well as by the absence of alternative voices within the current US administration. The U.S. decision to reach out to Russian President Vladimir Putin, ignoring European request for a seat at the able in the negotiations to end the Ukraine war, is often framed as a strategic move to prevent Russia from aligning more closely with China. However, it's difficult to ignore how this shift aligns with - and is likely backed by - the will of American voters.

There are some analysts who believe peace in Ukraine will bring lower gas prices in Europe - in fact, European equities initially rallied as news of a potential negotiations came out. But it would be naive to think that the continent could go back to a time when relationships with Russia were cordial and the NATO “umbrella” was taken for granted.

In a piece we wrote at the end of October last year, we mentioned how Germany (and Europe more widely) would have had to make a decision between paying a higher price for NATO to survive, or accept a decisive increase of Russian influence on the continent.

We were, in fact, optimistically wrong. The reality is direr, as Europeans find themselves stuck between two military superpowers - and China lurking in the background - that share a vision of a world divided into spheres of influence.

In the best case scenario, one where war is averted, trade restrictions will damage the European economic model, which heavily relies on exports. In the worst one, where an emboldened Russian President Vladimir Putin decides to re-annex the Baltic states (or finish off Ukraine), the question would be whether the triggering of article 5 of the NATO charter would force the US to intervene.

Our answer is clear. The NATO Charter is dead when it comes to its automatic triggers. President Trump has signaled it, and the US electorate is strongly supporting his position.

The Conundrum of Europe’s Rearmament

But if the US no longer guarantee European security, then what?

A decision to create a European army, as floated provocatively by Ukrainian President Volodymyr Zelensky, would create economies of scale in terms of procurement and manpower, and would save European countries substantial amount of money.

But in order to create an army, Europeans would have to have a clear, shared foreign policy vision, a leaner decision-making process and chain of command, and a pan-European armaments industry. None of these currently exists and - as the recent Paris summit clearly showed - Europeans, as usual, disagree as to how to start building them. And even assuming countries could start pooling substantial resources today, it would take a decade to replace US capabilities (among which there is, crucially, transporting troops rapidly and effectively to the frontline).

Europe doesn’t have that kind of time, not according to well respected military experts.

In a scenario where European countries would have to proceed autonomously, with limited coordination, the cost of building up often neglected militaries appears prohibitive.

The backdrop is one of large sovereign debts across all European countries, after substantial pandemic-related spending. Additional constraints would come from US tariffs that will have both a direct and indirect negative effects on Europe’s already sluggish growth.

Case in point, as European defense stocks rallied on the news of US’s disengagement, sovereign debt yields also rose in anticipation of what is seen as a potentially unsustainable increase in defense spending. The spiraling effect could potentially be compounded by a decrease in appetite for euro-denominated asset as fears of a war - with Russia? - increase.

A Reuters piece reports that “S&P Global estimates that attaining defence spends of 5% of GDP would cost (European countries) a total $875 billion a year, or "far beyond what individual states can finance without offsetting such outlays with other spending reductions or likely pressuring their creditworthiness".

Is (THIS) Peace in Ukraine a Positive for Europe?

The rally in European equities that followed the announcement of the beginning of a negotiation between the US and Russia on Ukraine can be explained by the expectation of diminished geopolitical uncertainty and lower energy prices for European companies.

Two fundamental questions need to be answered in that regard: First, can a negotiation between two superpowers deliver a lasting peace if it excludes the demands of the very nation that has fought so resolutely for three years? Second, can the European Union survive as a political project if it lacks the power, unity, and resolve to support a country destined to become one of its own?

The outcome of the negotiations between Russia and the United States - absent the European Union - is unlikely to take into account European interests, an ominous sign. Dependent on either Russia or the U.S. for energy, and now facing the prospect of losing access to critical rare earth minerals from Greenland and Ukraine, Europe risks being sidelined in the race for future technologies. How this could be seen as a positive for European equities remains a mystery.

But even if the war ended tomorrow and EU-Russia relationships (and access to cheaper Russian energy) were fully restored, enough bad blood exists between the two sides - and now even more so after the Europeans have shown strong support for Zelensky - that it is inconceivable to think President Putin will show any goodwill, especially right after he would have gotten away with the largest land grab in Europe since World War II.

The bottom line is: A defeated Putin is dangerous. A victorious Putin could be unstoppable.

Not to say that the continuation of the war would be positive for European assets…If the war drags on without American help, the Europeans would have to fork off a prohibitive amount of money and resources to support Ukraine, something for which the political will is - at best - uncertain. It would be a bold choice, but it may be an impossible one to take.

Conclusion

Analysts are not in the business of endorsing or condemning policy moves. They are in the business of trying to make sense of reality, with the help of prior knowledge - both direct and indirect - and the skills to understand it.

We had signaled in October last year that a Trump victory would accelerate the process of “multipolarization,” with the United States narrowing their focus on geographies and political objectives closer to home.

Europe’s long-standing assumption - that the U.S. would always underwrite its security - has been shattered. The transatlantic alliance that shaped the post-war order is unraveling, leaving Europe to confront a stark reality: it has to decide whether to rearm fast, with the risk of irking both Russia and the United States (if it does not buy American weapons), or passively witness its own demise, potentially undermining the future of the European Union as a political project.

Additional Reads:

EU Seeks a Military Revival Under Pressure From Putin, Trump

Germany has committed to improving its defense. Its budget needs to reflect this

Defense spending: How to pay for Germany's security?

US no longer an ally of Europe, ex-Nato official warns — as it happened: “We can certainly no longer rely on the trans-Atlantic relationship as we have come to know it for the past 75 years. And we have to create something new,” Babst argued.

Squeezed Between Putin and Trump, Europe Sees a Moment of Truth

European Defense Stocks Rise