A warm welcome to all the many new subscribers over the past week and particular thanks to those who have become paid subscribers. Amazingly, this newsletter now goes to more than 10,000 people in 113 countries including all 50 US states. Your interest and support is hugely appreciated. This post is free to read so please do share with anyone you think may be interested. And if you can afford it, please do consider becoming a paid subscriber. In the meantime, I look forward as always to your comments and feedback!

On a separate note, I will be in Madrid next week where I am very much looking forward to speaking at the Aspen Institute Espana about The End of the Economic World as we Knew It. Details and tickets can be found here. It would be great to catch up with any Wealth of Nations subscribers who can make it.

In this newsletter:

• Death of the West (Pt 2): Europe’s worst nightmare

• Sell America: the new Trump trade!

• European Rules: Time to enforce them

• Romania’s New President: Liberalism’s last hope?

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1. Death of the West (Pt 2)

Soon after Donald Trump returned to the White House, I noted that three things already seemed clear: that Trump considers Ukraine to be a part of Russia’s sphere of influence and would be willing to hand it to Vladimir Putin on a plate to end the war; that in abandoning Ukraine, whose fight for survival is existential to wider European security, Trump was turning America’s back on Europe itself; and that the Trump administration does not just hate the European Union as a challenge to his worldview but would actively seek to break it.

Since then, European leaders have done their valiant best to disprove this bleak prognosis and convince Trump that there is value yet in “the West”, broadly defined as an alliance of democracies bound by common values and a commitment to a rules-based order. Yet recent events suggest they have failed.

First there was Trump’s speech in Saudi Arabia in which he set out what amounts to a new Trump doctrine: America will no longer seek to promote its values but will do deals with anyone “even if our differences may be very profound”. That was followed by last week’s two hour phone call with Vladimir Putin in which Trump appeared to wash his hands of Ukraine. Then came Friday’s threat to impose a 50 percent tariff on EU imports from June 1.

The outcome of the Trump-Putin phone call was particularly humiliating for Europeans because the leaders of Britain, France and Germany had barely a week earlier travelled to Kyiv where, alongside Volodmyr Zelenskyy, they believed they had secured a commitment from Trump to impose tough sanctions on Russia if Putin did not agree to a ceasefire. Yet not only did Trump not impose sanctions when Putin refused a ceasefire, he effectively invited Putin to carry on fighting:

"I think something is going to happen. And if it doesn't I'll just back away and they'll have to keep going."

Putin certainly has kept going, unleashing some of the most ferocious aerial assaults on Ukrainian civilians of the entire war. Yet even as Trump took to Truth Social last night to vent his frustration with Putin (“Something has happened to him. He has gone absolutely CRAZY”), there was still no commitment to introduce sanctions, let alone step up support for Ukraine. Instead Europeans are left wondering what Trump means by backing away: will he continue to deliver weapons and allow intelligence-sharing? Or will he pull the rug entirely?

This is the context in which Trump dropped his tariff announcement last week. Even as he was abandoning Europe on the battlefield, he was choosing to declare economic war against the EU. That fits a pattern. He has never hid his hostility to the EU, declaring it “nasty” and “worse than China”. He resents smaller countries “banding together” to negotiate with America as equals. He would prefer to negotiate bilaterally with national governments, as he did with post-Brexit Britain, with whom he struck a one-sided deal that has left it facing higher tariffs. Holding the fate of Ukraine in his hands gives him leverage.

The good news is that Trump has already backed down, postponing the 50 percent tariff until July 9 following a “good call” with Commission President Ursula von der Leyen, their first proper conversation since he returned to office. In reality, he had little choice because the threat was preposterous, amount to an effective embargo on EU imports. The hit to the EU economy would have been up to two percent of GDP, according to Gilles Moec, chief economist at Axa Group. But the damage to the US economy would have been severe too - a hit of around 0.8 percent of GDP this year, and that is before any retaliation.

Yet Trump’s demands are also preposterous and, unless he drops them, will make reaching a deal very difficult. Demands that the EU drop its value-added tax or digital services tax, or rewrite its competition, health and digital security rules as a way to reduce its large trade surplus in goods are clearly a non-starter. Meanwhile the EU has made clear that it would not settle for the kind of one-sided deal agreed by the UK and if hit by higher tariffs would retaliate. It is a sign of these extraordinary times that the Trump administration may find it easier to reach a deal with China, an adversary with whom it does indeed have “profound differences”, than with the EU, supposedly a steadfast ally.

Indeed, the EU finds itself facing its worst nightmare, in which questions of security and trade have become entwined in a way that threatens to deepen divisions not just between the EU and US but within the EU itself. What is also clear is that Trump will attempt to encourage and exploit those divisions, particularly over security, to try to force concessions and undermine the EU. Indeed, Treasury secretary Scott Bessent has been clear about this, blaming a “collective action problem” for a lack of progress in negotiations and accusing Brussels of frustrating the wishes of some national governments to strike a deal.

European diplomats will continue in their quest to convince this most transactional of presidents of the benefits to the old western alliance, in the hope of saving Ukraine and sparing their economies. But the lesson of the last week is the same as that in February: if Europeans want to be a pole in the emerging multipolar world, they need to able to provide for their own collective security. Otherwise, they will find themselves pieces on someone else’s chessboard.

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2. Sell America

No doubt one factor behind Trump’s quick U-turn on the EU 50 percent tariff was the market reaction. Eurozone 2-year bond yields fell in anticipation of further interest rate cuts, widening the interest rate differential with US Treasury yields, yet the dollar also fell. That is the opposite of what one would normally expect to happen. Indeed, it capped what was a pretty uncomfortable week in the markets for US assets. The yield on 30-year US Treasury bonds rose above five percent, their highest level since 2007, while the dollar fell about one percent, evidence that global investors are continuing to “Sell America”.

What had sparked last week’s sell-off was investor concerns over the US budget, after the House of Representative passed its version of Trump’s “big, beautiful bill”. This legislation is needed to roll over Trump’s first term tax cuts and implement his campaign tax cut and spending promises will lead to a significant increase in the US debt and deficit, reckons Bank of America:

The fiscal bill being discussed in Congress that barely passed the House this week implies a mild expansion of the current deficit for the upcoming years, even accounting for expected tariff revenues close to 1pp of GDP. This is already alarming given that the headline deficit is expected to reach 6.3% of GDP this year, a record number for an economy that was running at full employment before the tariff and uncertainty shocks.

However, we expect the Senate to push back on spending cuts such as Medicaid and likely end up approving an even more expansionary fiscal bill. In our baseline scenario, we expect the headline deficit to reach 6.9% of GDP in 2026, with a primary deficit of 3.5% of GDP.

Not surprisingly, this is raising concerns over long-term US debt sustainability in a world of higher interest rates. Already US government interest payments are on course to exceed defence spending this year. Investor jitters were not helped by a weak auction for a new 20-year Treasury bond last week. Remarkably, Microsoft’s 30-year bonds now yield less than the US government, suggesting investors consider them a safer bet. Meanwhile the yield on the 10-year US Treasury at 4.51 percent is well above the “yippy” level that triggered the 90-day tariff pause.

Inevitably, that has prompted speculation as to whether America could be heading for a Liz Truss moment - a question Wealth of Nations has been pondering all year. Paul Krugman has a good post on this here. It does not help that the Trump administration and its media cheerleaders have been adopting some distinctively Truss-ite arguments, insisting that tax cuts will ultimately prove magically growth-enhancing so worries about the debt are unfounded. The markets did not buy this voodoo economics in Britain, why would they now?

Trump’s decision last week to reignite his trade war has only raised fresh questions over the credibility of US policymaking. That in turn will fuel concerns over US growth, and thus tax receipts and a deepening deficit. One way or another, it seems likely that the dollar will need to fall a lot lower and Treasury yields rise even higher to continue to attract global investors. The big question is whether it could ultimately lead to a crisis in which the markets force Congress to do its job and either cut spending or raise taxes.

As Claudio Irigoyen, global economist at Bank of America, warns:

The famous economist Rudi Dornbusch used to say that "In economics, things take longer than expected to happen than you think they will, and then they happen faster than you thought they could". A buyer strike might be around the corner.

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3. European Rules

The best response that the EU could provide to Trump’s trade war would be to take action to improve the functioning of its own economy, along the lines set out with brutal clarity in the reports last year by former Italian prime ministers Mario Draghi and Enrico Letta. But while a great deal of attention has focused on what new things the EU could be doing to improve the functioning of the single market, some of the biggest prizes are in improving what it does already.

For example, some of the lowest hanging fruit is surely to revisit the highly burdensome regulation that has helped turn the EU into a tech laggard. An excellent piece in the Wall Street Journal this week by Tom Fairless and David Luhnow highlighted some of the ways that EU’s over-zealous rules are contributing to an exodus of tech entrepreneurs and businesses:

European businesses spend 40% of their IT budgets on complying with regulations, according to a recent survey by Amazon. Two-thirds of European businesses don’t understand their obligations under the EU’s AI Act, which came into force last summer, the survey found.

Meta delayed the launch of its latest AI model in Europe by nearly a year because of EU regulations. It began rolling out a limited version in March that doesn’t include features like image generation or editing. Apple also postponed its new AI features for iPhones in Europe until recent weeks.

But the WSJ also notes that an even bigger problem is that more than 30 years after the launch of the single market, the EU economy remains very fragmented:

Scaling up quickly in Europe is hard. The U.S. is a large integrated market, while Europe has dozens of countries with their own language, laws and taxes. Labor laws slow down worker mobility by making it harder to hire and fire workers. (There is often a three-month notice period in Europe for leaving a firm, and in some cases a six-month noncompete clause, jokingly known in Britain as “gardening leave.”)

This fragmentation carries a huge cost. One dismal statistic that I have highlighted here a few times is the IMF’s calculation that the internal barriers to trade within the EU are equivalent to a 45 percent tariffs on goods and a 110 percent tariffs on services - higher than Trump’s threatened “reciprocal” tariffs. What’s more, many of these internal barriers to trade amount to little more than covert protectionism that run contrary to single market rules.

What this suggests is that the Commission, which is supposed to enforce EU rules, is failing do its job properly. Indeed, this excellent recent Substack post by Luis Garicano, professor of public policy at the London School of Economics and a former Member of the European Parliament, provides the evidence:

As of December 2024, only 658 Single-Market infringement cases were pending, 6% fewer than a year earlier and 21% fewer than in 2020. In the previous twelve months, the Commission opened just 173 new cases – only a quarter of the volume handled a decade ago. The 2023 Annual Enforcement Report shows just 529 new infringement procedures across all policy fields, down from 1,347 in 2013. A Financial Times analysis found that formal action for breaches of EU law opened by the Commission against EU countries had fallen by 80% in the first 3 years of the Von der Leyen Commission.

The reason enforcement goes down is not that member states are suddenly complying better with the rules. According to the Single Market Scoreboard, the average case duration stands at 45.8 months—31% longer than in 2019—and member states now take 61.3 months on average to comply with Court rulings, double the figure from five years earlier.

Why has the Commission seemingly abandoned one of its core functions as enforcer of the Treaties? Part of the answer is that the role of the Commission has changed. In the years before the global financial crisis, it saw itself - and was seen - as a largely technocratic institution whose primary role was to work on behalf of businesses to prise open national markets and ensure level playing fields. But in the years since the eurozone debt crisis, it has become deliberately more political. Now it sees its task as securing the support of national governments for new EU initiatives far removed from the economy.

On the face of it, this increased responsiveness to national governments may come across as more democratic. But there is nothing democratic about failing to enforce laws that have been agreed by 27 national governments and the European Parliament. Nor has the Commission’s prestige and authority been enhanced by its deference to rule-breaking national governments. Instead, Europe’s lacklustre growth performance, in part arising from the failed promise of its single market, is undermining the EU’s own legitimacy and fuelling the rise of populism.

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4. Romania’s New President

When it comes to the rise of populism, much of Europe breathed a sigh of relief last weekend when mainstream candidates prevailed over the right-wing populists in elections in Romania, Poland and Portugal. In particular, the victory of Nicuşor Dan, the Mayor Bucharest, in Romania’s presidential election over the far-right, Putin-sympathising George Simion was particularly welcome.

But this piece by Veronica Anghel, assistant Professor at European University Institute, in Foreign Affairs is a reminder that the new president, who finds himself at the head of a country without a government and with a hung parliament faces formidable challenges:

Despite years of strong growth in GDP and deeper integration into European markets, the government has brought little improvement in standard of living to much of the country’s population. Along with high inequality, nearly a third of the population is at risk of poverty. The country also has the highest school dropout rates in the EU, and rural youth unemployment exceeds 30 percent, even as jobs go unfilled in major cities. The divide is the result of decades of absent or mismanaged investment in rural infrastructure. Meanwhile, the country’s entrenched political classes are seen by many ordinary Romanians as corrupt, self-dealing, and lacking a positive vision for Romania’s future.

Meanwhile, the signs of potential economic collapse are growing. Romania’s fiscal system, which is based on a flat tax approach and suffers from chronically low revenue collections, has left the state unable to enact redistributive policies needed to narrow the country’s huge inequality gap and fix its dysfunctional public services. Dan and his coalition will need to urgently address these structural fractures to avoid further defections to the far right.

The scale of the economic challenge was spelled out by Goldman Sachs:

The election takes place against the backdrop of acute fiscal and external funding challenges. Romania’s fiscal deficit stood at 9.3% of GDP in 2024 and, largely because of the fiscal deficit, its current account deficit is also running at 9-10% of GDP. The Romanian Ministry of Finance is targeting a fiscal deficit of 7.0% of GDP for 2025, but the fiscal data for this year show little sign of improvement.

When one considers that the United States, with the Republican Party in full control of the Presidency and Congress, is unable to get to grips with its fiscal crisis, the challenge facing Dan looks even more daunting. Indeed, even the British government with a vast majority and no election due for four years, has been unable to resist demands to reverse even modest cuts in welfare spending needed to get its debt under control. Yet Romania needs to deliver far-reaching reform if it is to see off the continued threat from the far right. As Anghel says:

The liberal order in Romania has survived, for now. But it stands on alarmingly fragile ground.

The same could be said for pretty much everywhere in Europe.

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