Will Trump trigger a Eurozone debt crisis?

COMMENT |  Desmond Lachman |  At the first cabinet meeting of his second term, US President Donald Trump declared his intention to impose a sweeping 25% tariff on all imports from the European Union. But before opening a European front in his trade war, Trump might want to consider the continent’s economic malaise: the German economy has been experiencing a prolonged downturn, while Italy and France are struggling with serious public-debt problems. Maybe then Trump will grasp that his tariff actions – part of his “America First” agenda – risk triggering a European-wide recession and another eurozone debt crisis.

Some might argue that Trump has no interest in Europe’s fate. But given how badly the 2010 Greek debt implosion shook US and world financial markets, similar crises in France and Italy, the European Union’s second- and third-largest economies (and many times the size of Greece’s), would have truly catastrophic consequences for markets and the global economy. That is the last thing Trump needs on his watch.

Germany’s recent economic woes, like Shakespeare’s sorrows, “come not single spies but in battalions.” They include COVID-related supply-chain disruptions, an energy shock caused by Russia’s invasion of Ukraine, a major slowdown in Chinese demand for German capital goods (following the collapse of the Chinese housing-market bubble), and increased competition from Chinese firms, especially in the automotive and clean-energy sectors. Under these circumstances, and given that exports account for nearly 50% of its GDP, Germany can ill afford US import tariffs.

It is difficult to overstate the adverse effects that the aforementioned shocks have had on the German economy. Since the start of the pandemic in 2020, the US economy has grown by 12%, whereas the German economy experienced no growth in output, and even fell into recession in 2023, from which it has yet to recover. Now, the Bundesbank is warning that Trump’s proposed import tariffs could cause the German economy to contract by 1.5% in 2027.

Unfortunately, all signs point to Trump setting his sights on Europe in general, and on Germany in particular, as the next target of his trade war. Following his 25% tariff on steel and aluminum imports, Trump is contemplating similar duties on automobiles and pharmaceutical products – a large share of which the US imports from Germany. He has also threatened “reciprocal” tariffs to match those of America’s trading partners, while pledging to target countries that have large bilateral trade surpluses with the US. In 2024, Germany’s trade surplus with America reached a record $72 billion.

Meanwhile, Italy and France currently have higher public debt-to-GDP ratios than they did during the eurozone sovereign-debt crisis of 2010-12. These governments have also amassed unsustainably large budget deficits, but seemingly lack the political will to address their public-finance problems.

Even if they mustered the political will to act, it would be difficult for Italy and France to put their public debt on a sustainable path. Stuck in the euro straitjacket, these countries cannot use interest-rate or exchange-rate policy to boost exports or consumer demand to offset the contractionary effect of fiscal belt-tightening on aggregate demand. Moreover, a significant downturn in the German economy would make it even more difficult for these countries to reduce their debt burdens, because demand for their exports would fall.

Europe’s last hope is that Trump recognizes, before it is too late, that triggering a recession and a debt crisis in Europe is not in America’s economic interest. As the Greek sovereign-debt crisis illustrated, the US financial system has considerable exposure to the European economy. At the same time, a eurozone recession would likely be bad news for Trump’s beloved stock market, because around 40% of the S&P 500 companies’ profits are derived from their overseas operations.

But hope is not a strategy, especially at a time when Trump seems fully committed to an aggressive “America First” trade policy. Instead, European policymakers should ready themselves for an all-out trade war. The best defense would be to undertake the bold structural reforms that Mario Draghi, the former president of the European Central Bank, proposed last September to restore the bloc’s competitiveness.

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Desmond Lachman, a senior fellow at the American Enterprise Institute, is a former deputy director of the International Monetary Fund’s Policy Development and Review Department and a former chief emerging-market economic strategist at Salomon Smith Barney.

Copyright: Project Syndicate, 2025.
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