Trump’s trade war will make or break the European Union

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The layman’s narrative of the 1930s is that America’s Smoot-Hawley tariffs set off a beggar-thy-neighbour spiral and caused the Great Depression. It is not true.

This free-trade ideology lies behind much of the confusion over what may happen if Donald Trump goes ahead with his 10pc or 20pc tariffs against everybody and 60pc tariffs against China.

The depression was caused by the break-down of the inter-war Gold Standard and above all by the scorched-earth policies of the US Federal Reserve. The violent contraction of the US money supply between 1930 and 1932 led to debt deflation and the failure of 4,000 banks. Fed policy was transmitted globally by gold flows.

Gary Hufbauer, the US trade historian, says the Fordney-McCumber tariffs of 1922 were more significant. They raised average duties from 16pc to 36pc. This did not prevent the economic boom of the Roaring Twenties in the US.

Europeans instead suffered the brunt of the shock: they could not earn sufficient dollars to service their war-time debts. It was an indirect factor behind the many hyperinflations of 1923 and 1924.

There is a second lesson from the inter-war years. Britain was a chronic deficit country in the 1920s and early 1930s (because of an overvalued gold peg). It was forced off the Gold Standard in 1931, which proved liberating.

Britain abandoned free trade and retreated behind Imperial Preference along with the empire. This allowed the Bank of England to slash interest rates and reflate behind a protected tariff wall, ushering in the glory years of the car industry in the Midlands. Britain greatly outperformed America in the 1930s – a feat never since repeated.

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The tale of that decade is that protectionism works in specific circumstances. You come off better in a trade war if a) you are a deficit country and b) if you cushion the blow with aggressive stimulus. Which brings one to the ghastly predicament facing Europe today.

The EU’s retaliatory tariffs are locked and loaded. “If Trump does go ahead with his tariff fantasies, then we will bring him back to reality and defend ourselves,” said Bernd Lange, chairman of the European Parliament’s trade committee.

The European Commission has an arsenal of weapons, including its anti-coercion instrument. It has drawn up a list of targets in Republican districts that do maximum political damage without snarling up supply chains.

The first giant problem with this bravado is that the EU depends on US military protection for its survival and provoking Trump is the most certain way to get this removed.

There is a view among advocates of a muscular European superstate that Trump is a gift from Mars, the necessary catalyst for the acceptance of an EU treasury and armed forces with power projection. “Eine Chance für die EU!”, said Germany’s Friedrich-Naumann-Stiftung.

France’s Emmanuel Macron fears it may have the opposite outcome. The EU will be split along various lines of cleavage, with clashing interests over exposure to China and the US and clashing ideologies over Trumpism. “The risk is that certain countries will be tempted to go their own way, to go with America,” he said at a recent round-table at the College de France.

Francis Fukuyama, the prophet of democratic liberalism, thinks Italy’s Giorgia Meloni will reveal a different face, leading a clutch of dissident EU states into Trump’s orbit out of culture war affinity – egged on by Geert Wilders, the Dutch politician.

The second giant problem is that Trump will not be deterred by retaliation and the economic consequences are asymmetric. The EU has a structural trade surplus with the US heading for $230bn (£183bn) this year and the lion’s share consists of German exports of cars, chemicals and pharma.

Europe will suffer far more damage from a tariff war and it is in no fit state to withstand that damage. One can easily discern a chain of events that would test the EU to near-destruction.

The EU prides itself on being the last defender of the world’s open trading system. This is a charming conceit. It has 10pc tariffs on cars (why?) and 11pc average tariffs on agriculture, viz 2.5pc and 3.6pc for the US respectively – leaving aside Chinese electric vehicles. The EU has weaponised the precautionary principle for years to keep out US grains, chicken and beef.

As Trump says: “They don’t take our cars. They don’t take our farm products. They don’t take anything. The EU is a mini – but not so mini – a mini-China.”

Europe would also be caught in the fall-out from Trump’s trade war with China. A fresh tsunami of Chinese goods would be diverted into Europe, leaving the EU with an invidious choice: either to erect its own tariff wall and set off a wider disintegration of the trading system or face the further obliteration of its manufacturing base.

President Macron is candid over how Europe ended up in this mess. “We have made a trade-off in macroeconomic policy that favours the export-led model. When exports stall, we are hit harder,” he said.

Ursula von der Leyen, the president of the European Commission, hopes to assuage Trump by playing to one of his obsessions: liquefied natural gas (LNG). “We still get a whole lot of LNG from Russia. Why not replace it with American LNG?” she said.

But the EU’s own energy agency says Europe’s LNG demand has peaked and will be whittled away to marginal volumes by 2030 under the REPowerEU renewables plan. Brussels would have to compel the abrogation of private pipeline contracts with Norway and Algeria to make way for more LNG, which would be political and ecological madness.

China is reportedly holding a mammoth fiscal package in reserve to parry the blow when Trump imposes his tariffs. Europe has no such plan. It is set on a path of fiscal contraction.

The eurozone is back in its familiar condition of near-zero growth. It needs a massive public investment to escape a bad equilibrium, and massive military re-armament to escape “Finlandisation”. Yet seven countries are under an excessive deficit procedure – including France, Italy, Poland and Belgium – and face legal action unless they cut their deficits.

Stefan Schaible, the head of consultants Roland Berger, said Germany faced a “horror scenario” unless it launched an investment blitz of up to €400bn (£333bn) in energy, infrastructure and education, accompanied by a restructuring plan.

“The situation is really critical. Germany is slipping away from us,” he told Handelsblatt, the newspaper.

Yet austerity is written into the German constitution through the debt-brake. It is written into EU law through a machinery of budget surveillance,  imposed by Berlin to police Club Med debts. Such are the contortions that follow from the original sin of launching monetary union without fiscal union.

Eurozone countries were told to export their way out of trouble as a condition for bail-outs in the 2010s. They all slashed investment and cut military spending to the bone. This approach was and remains toxic in every respect.

This economic and political model could endure only as long as the US was willing to act as both buyer and defender of last resort. Trump is no longer willing to do either. The reckoning is coming.

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