US economic war on Europe a disaster for a divided West

This is a free extract from Iain Martin’s weekly newsletter, exclusively for Reaction subscribers.

Imagine if Donald Trump had introduced a $400bn package of subsidies to US industry amounting to a declaration of industrial warfare against Europe. In such circumstances the former President would have been denounced. Famous liberal writers would have said this proved a populist, nativist leader was putting America’s industrial needs first to the huge detriment of European allies facing the Russian threat. There would have been weeping and wailing on the pages of the New York Times (AKA the World’s Worst Newspaper) about Trump’s bull in a china shop behaviour.

Instead, it is President Biden’s administration implementing just such a plan, so the response has been muted and the criticism respectful. Other than a handful of geopolitical specialists, columnists including my colleague Simon Nixon on the Times, and the European Commission, very few people seem to have clocked the sheer enormity of this development.

In Britain, I have looked and cannot – yet – locate the person in the British governing system who is thinking and working on this most urgent and worrying of subjects. Let me know if you find him or her.

In effect, the Biden administration with its Inflation Reduction Act is giving substantial subsidies and tax breaks to businesses inside the US manufacturing the stuff of the future. There’s a green focus to it, batteries and the like, of course, and a lot of tax fiddling and performative, left-leaning “anti-rich” add ons too. This is the contemporary Democrats, after all.

But the $400bn is not the half of it. It’s perhaps ten times worse than that. I’ve now heard several estimates from City analysts on what’s about to happen. The $400bn will be leveraged, that is for every dollar of state intervention US institutions, investors, companies will pour in more to exploit the subsidies. They will add perhaps another $3.5trillion of firepower. From one expert source I’ve seen the total impact estimated at $4.5trillion. That’s capital that might have been deployed outside the US in other places as inward investment, used instead for lighting a fire under US industrial production to serve its domestic market with cheaper goods.

Think of the US as a giant money machine, a single market using the world’s leading currency with deep, deep pools of private and institutional capital to deploy on a scale Europe, and Britain, simply cannot contemplate. Plus enormous risk appetite and hunger for growth.

The EU has held meetings this week trying to work out how to respond. It will try some subsidies of its own, but is going to struggle to coordinate a response to match the US government’s $400bn, and the countries fear the larger states getting more.

Much, much worse, the EU does not have deep capital markets to match the US leverage either. Attempts have been made to create an EU Capital Markets Union, meaning one EU-wide market in capital. No-one can ever agree on what it looks like.

If the EU gets together three quarters or so of the $400bn the US State is spending it will be doing well. But there won’t be anything like the leverage to follow in Europe compared to the US. Europe is in serious trouble here.

Any Brits tempted to laugh should forget it. We are stuck in the middle, unable to match even the EU’s measly firepower and dwarfed by the US.

When the US offers these protectionist tax breaks and subsidies, it will attract companies and trigger a great sucking out from across all of Europe. It is already starting to happen it is said, as companies choose to deploy investment capital years ahead, to build the next generation of factories and infrastructure in the US rather than Europe or elsewhere. This risks hollowing out European manufacturing.

What the Biden administration is doing, possibly unwittingly, certainly unthinkingly, is potentially calamitous for its allies. Deindustrialisation means economic decline and unemployment, creating the conditions for the emergence of populists who may say the US is suiting itself, and it is. Or populists will pick other targets domestically to blame for deindustrialisation.

Regular readers will know how obsessed I am – having written financial histories and sat next to Simon Nixon years ago when we were at the WSJ – with the way in which post-Second World War history is best understood as an explosion of money, a rolling revolution in terms of scale and innovation in how debt once created is traded. Lay on top of that the role of energy shocks, in 1973, 1979 and 2022.

One of the main drivers of history since the War has been the switch to open flows of capital across borders supercharged by computerisation. Money in ever larger amounts moves. Britain has depended on this since the Thatcher government sensibly scrapped exchange controls limiting what money could leave the country. The City has been expert at exploiting this explosion since the 1960s and even more since the 1980s reforms.

This stuff is not a subject most politicians usually want to hear about or discuss, perhaps because it is hard to understand in terms of scale, or it is frightening and hard to explain to us voters. Our leaders will instead say we must invest in the jobs and skills of the future, and everyone nods along with platitudes. Investing in jobs and skills with public spending is important, of course, but it’s miniscule when viewed against the movement of trillions of dollars of mobile capital that dictates where business is done and where growth happens.

The implementation of the US legislation is not straightforward. Democratic Senator Joe Manchin is causing the White House headaches. He represents fossil-fuel friendly West Virginia and he objects to the green focus.

It looks likely the full plan will roll out, though, with tweaks. Biden is making positive noises about oil and gas still being needed for the energy transition, which it is.

Perhaps the most worrying aspect of this episode, beyond the economic carnage ahead, is the impact on the alliance of the democracies.

Ukraine is about to be tested and it is not guaranteed it will win. At the very point when the US and Europe, including Britain, are standing together (broadly) in the face of the Russian threat there is a great economic division and divergence coming.

The US will motor ahead, becoming even more of a growth machine. The EU and the UK are left with a chronic problem to sort.

City of London could help, here’s how

Here’s one positive idea, and a creative way to think about Europe’s problem.

The City of London could help fix it – if the EU is open-minded enough to see how the City may be the answer.

The City excels at raising vast amounts of international capital, sucking in money that might go elsewhere, recycling and trading debt and all manner of instruments, along with managing foreign exchange. And creating new products.

Why not build a new product or two here to service the European need for financial leverage, to supercharge whatever industrial subsidies the EU does agree?

The City did it in the early 1960s, when Warburg pioneered the Eurobond, a way of tapping, for European infrastructure and industrial investment, into dollars trapped off shore from America by the Kennedy administration’s tax changes. It grew rapidly, became Europe’s second biggest debt market from one simple idea, and attracted the Japanese and the Americans.

This time it also needs to be simple – with a good name. Let’s call them Eurofuturegrowth bonds or something if that’s available.

London could organise it, and the deals could then be distributed through Europe.

It needs a little imaginative help from the Treasury. Government couldn’t run this, it should only create the conditions or it’ll never happen.

Work out what the regulatory gain or advantage offered to investors internationally to put their money into this European project might be.

What’s the tax offer in the UK to investors?

Neither Paris nor Berlin have the financial market clout to do this, and to leverage European investment more broadly.

The prize would be more job-boosting investment across Europe and a shot at minimising the deindustrialisation.

London could and should be thinking about what to do, and quick.

Zelensky proves the power of the individual in history

Many thousands of words have been written about the uplifting visit of President Zelensky to London this week and the magnificence of his speech. I won’t add to them, other than to observe that once again we see the importance of the role of the individual in history in action.

A year ago, with the US, the UK and Canada warning Russia was about to attack Ukraine, or expand the scope of the war it started in 2014, much smart opinion was dismissive. Putin wouldn’t invade. Too much at risk.

It turned out his mad scribblings in his history essays penned in the Russian leader’s weird isolation were to be taken at face value. He meant it all.

Even among Ukraine’s allies there was a reasonable assumption Russia would win in days or weeks, so overwhelming was its advantage in terms of firepower. Ukraine’s leader would flee into exile was the expectation.

There are many reasons the war did not work out that way after 24 February. Russian military corruption and incompetence were factors.

Zelensky himself was essential. With that brave, emotion-driven decision to stay, the man changed history. His people knew they were not being abandoned and fought back even harder. The capital was saved and Ukrainian fighting morale surged, even throughout significant setbacks elsewhere.

Let’s hope it holds, that Zelensky can do it again and Ukraine withstands the horror the tyrannical Russian state is getting ready to inflict.

These go to eleven

Did you know they are making a new Spinal Tap movie? Did you know about the old one? If you’ve never heard of or never seen this film you can either look away or skip to the next item. Alternatively, you could take this tip and go and watch Spinal Tap, a spoof documentary of a faded British rock band touring the US. You are unlikely to be disappointed

As a devotee of the film – time was when I watched it weekly and knew most of the dialogue by heart – I had no idea the director Rob Reiner was working on a second film, ahead of the fortieth anniversary of the release of the original next year.

Reaction columnist David Waywell mentioned in passing the new Tap film in his (partial) defence of John Cleese, who announced a few days ago he is planning a new Fawlty Towers. Some fans were appalled. Isn’t the point of Fawlty Towers that he only made twelve episodes over two series and they’re all perfect? Incidentally, they’re not perfect. A couple of episodes are weaker than the rest, albeit of such a high standard that they’re better than many other TV comedies.

A younger me would have been appalled by the idea of a Spinal Tap II. The actors and director created the perfect artefact, spoofing the music industry, the sadness of declining fame and mid-Atlantic madness as young boys from “Squatney”, London become rock gods and then fallen idols. Why risk tarnishing the memory?

For the same reason I feared the Beatles, or three of them, reforming for the Anthology project in the 1990s. It has been said many times that the beauty of the Beatles is that they had a beginning, a middle and an end. They never went off or produced substandard work, although they came close on parts of the White Album, a triumph of sequencing, track ordering hiding the weaknesses, according to Beatles chronicler Ian MacDonald. And Maxwell’s Silver Hammer on Abbey Road is an atrocity. I don’t mean the murder in the song. I mean it is one of Paul McCartney’s principal musical crimes. (Apologies to my friend Lord Finkelstein who likes it).

Now, if you’re a Beatles fan, imagine if they had never bothered with Anthology, telling their own story in the 1990s. George Harrison would have died without it being made and the moment would have gone forever, an opportunity lost to history. There is even something poignant about the two tracks they made for the series, recording over fragments of John Lennon demo tapes.

Rob Reiner’s a great director. He’ll do something good with those aged Spinal Tap actors. Apparently, in the new film they are forced to reunite because of a clause in their contract with their manager Ian Faith (a cricket bat wielding English maniac). Faith’s widow enforces the penalty clause, and they must reform. I can’t wait.

The reference in the headline on this item is to Nigel Tufnel, lead guitar, who when showing his guitar collection to Reiner’s character highlights that Marshall Amps had a special amp made for him that was extra loud. The volume dial went up to eleven.

Reiner asks: Why don’t they just make ten louder? Nigel looks confused.

But these go to eleven, Nigel responds.

Daring to dream

It’s hope that kills, as Scotland fans say. After last weekend at Twickenham, where I was among those watching a fascinating game of rugby, it’s off to Murrayfield for the Wales game today. As a Scot, the joy of last weekend was that the fear is gone and the fixture is now enjoyable rather than a guaranteed route to humiliation. England is a normal game. The Scots were outstanding. And a representative of the famous van der Merwe clan of Mallaig – or is it the Western Cape? – scored a dream try. Unfortunately, being a Scotland fan it’s either existential fear or hubristic over-confidence. Those are the options. Might we dare to dream about winning the Six Nations? What could possibly go wrong? You know the answer.