Sunday’s EU-US trade “deal” – if you can call it that – was a political catastrophe for Ursula von der Leyen, the European Commission, and the EU’s 27 member states.
Fortunately, it was not an economic one.
Most analyses of the agreement – which will see most EU exporters hit with a blanket 15% US levy – estimate the total cost to the bloc’s GDP to be around 0.5%: a serious blow that could push Europe’s anaemic economy into a recession, but which pales in comparison to the devastation wrought by the 2009 financial crisis (when output shrank by 4.3%) or the Covid pandemic in 2020 (when it plunged by 5.6%).
Why is the damage, in relative terms, so small? There are multiple reasons, but the main ones include the “price inelasticity” of many EU exports (rich Americans will, for instance, still buy Porsches even if they’re far more expensive); the likely redirection of trade flows to other regions (such as South America); and many European firms’ deep reluctance to relocate production to America (because of massive legal uncertainty and general Trump-induced insanity).
Indeed, the basic structure of the EU-US trade relationship, coupled with the “Tariff Man’s” desire to wage a trade war on the entire world, virtually guarantees that the harm inflicted on Europe would always be economically manageable, albeit painful for certain specific industries (especially the export-dependent pharmaceutical and auto sectors).
Although the US is the EU’s largest trading partner, the €532 billion in EU exports shipped across the Atlantic last year still amount to less than 3% of the bloc’s annual GDP – meaning that, even if all EU exports to America were to immediately cease (which is practically impossible), the net impact would still fall well short of the harm inflicted by the Great Recession and Covid-19.
(Nitpicky economists would point out that a complete collapse of EU exports would likely have harmful ‘secondary’ effects, such as skilled workers fleeing the continent, that would further hinder growth. But you get the point.)
Furthermore, Trump’s desire to impose tariffs on literally every single country (and occasional penguin-inhabited island) means that the relative competitiveness of EU exporters has actually increased as a result of Sunday’s agreement.
Mexico and Canada – America’s two largest trading partners – currently face 25% and 35% tariffs, respectively, on most exports to the US; China, the US’s third-largest trading partner and Europe’s second-largest, has also been hit with a 30% US levy: twice as high as the EU’s rate. (In a thinly veiled allusion to this fact, EU Trade Commissioner, Maroš Šefčovič, wrote on X this morning that “EU exporters now benefit from a more competitive position”.)
These considerations – and the fact that the EU has already successfully withstood a 10% US blanket levy since April – explain why analysts have largely shrugged off the anticipated impact of this week’s EU-US deal.
“It is not obvious that the EU is paying a much higher price than had been anticipated,” Deutsche Bank wrote in a note, as they increased the forecast impact of Trump’s tariffs on the bloc’s output from 0.4% to 0.5%.
Bloomberg Economics similarly noted that their anticipated impact of Trump’s tariffs on Europe remains “broadly unchanged” at 0.4% of GDP, although they warned that an “escalation” of duties on specific sectors, in particular pharmaceuticals, could “shave off” another 0.3%.
Historical fears
Arguably, the intense focus on Trump’s trade war has come at the expense of media attention on US policies which could, in fact, inflict just as much harm as the 2009 financial crisis – namely, by triggering another financial crisis.
In fact, US policymakers themselves have openly sounded the alarm about the potential impact of Washington’s push to massively deregulate America’s financial sector.
In a fascinating speech delivered at the Washington, DC-based Brookings Institution last month, Michael Barr, a governor of the US Federal Reserve, warned that periods of deregulatory zeal preceded all three of the most infamous financial meltdowns over the past century, namely the Great Depression in the 1930s, the “Savings & Loan” crisis in the late 1980s and early 1990s, and the 2009 global financial crisis that almost triggered the collapse of the euro area.
During the ensuing Q&A, Barr said that he “certainly worried” about the historical parallels to today’s situation, in which Washington has sought to slash banks’ capital buffers, weaken “stress testing” requirements, and erode federal supervision of highly volatile cryptocurrencies.
“An important lesson we can draw from US financial crises is the role that ill-advised weakening of the bank regulatory framework played in those crises,” Barr said. “It is well within our ability, and is our duty as regulators, to learn from these episodes to avoid making the same mistakes.”
Barr’s fears are widely shared by financial analysts. Indeed, some fear that the American deregulatory bug may already have spread to Europe.
Europe’s banking sector is “riding the wave of deregulation fetish even if profitability has been improving dramatically” as a result of the European Central Bank’s higher interest rates, said Sander Tordoir, chief economist at the Centre for European Reform.
Tordoir added that Europe’s push to slash regulations is a “strange sight to behold” given that Europe, unlike the US and Switzerland, successfully avoided a banking crisis in March 2023, when the collapse of San Francisco-based Silicon Valley Bank sparked widespread market panic that ultimately led to the failure of Credit Suisse and its acquisition by rival UBS.
“The supervision from the ECB and financial regulation put in place after 2008 surely has played a constructive role” in Europe’s avoidance of any spillover effects, Tordoir said. “It was a test and only the eurozone passed it with flying colours.”
Stupid risks
Tordoir’s fears have been echoed by other analysts.
Finance Watch, an NGO, recently warned that Brussels’ push to “simplify” the EU’s securitisation regulations – a sector that allows banks to repackage and sell loans and which played a key role in the 2009 crisis – could increase “systemic risk” in Europe’s financial sector.
Sceptics, however, argue that the risks posed by these efforts remain minimal, especially given that the EU’s securitisation market remains multiple times smaller than the US’s.
Some also note that the overall financial craziness in the US – including Trump’s repeated attacks on Fed independence, the passing of a deficit-busting federal budget, and the threatened imposition of US capital controls – has deterred EU policymakers from treading a similar path.
“Six months ago, there was a view that, if the US relaxes capital requirements, Europe would have to do the same to preserve the level playing field,” said Nicolas Véron, a senior fellow at Bruegel and the Peterson Institute for International Economics.
“But now the idea of the level playing field with the US under the Trump administration doesn’t really pass muster; the growing consensus in Europe is that Trump’s policies are dangerous and reckless.”
Véron also noted that Europe’s ability to withstand the “somewhat remote” possibility of a US-induced shock has improved over the past decade due to improvements to its banking supervision and overall financial architecture (e.g. the creation of the European Stability Mechanism, or euro area rescue fund).
“At this point the risk is no longer so much that the US will do something stupid and we will do the same stupid thing, but that the stupid things that happen in the US may create risks for Europe,” he said.
Economy News Roundup
The EU and US clinch trade deal. The agreement, announced on Sunday, averted the imposition of a 30% US blanket tariff on 1 August that threatened to upend the €1.7 trillion transatlantic trade relationship. The deal will see the EU face a blanket tariff of 15% on most goods; EU firms will also purchase $750 billion worth of US energy and invest $600 billion into America over and above what they have already pledged, Brussels said. Read more.
France condemns deal as “submission”. “It’s a dark day when an alliance of free peoples, united in their values and in the defence of their interests, resigns itself to submission,” Prime Minister François Bayrou said on Monday. European Affairs Minister Benjamin Haddad added that it was “urgent” for the EU to prepare to activate its “bazooka” anti-coercion instrument – the bloc’s most powerful trade weapon that could limit the American service industries access to EU markets. Read more.
The agreement was clinched to ensure support for Ukraine, says Brussels. “It’s about security; it’s about Ukraine; it’s about current geopolitical volatility,” EU Trade Commissioner Maroš Šefčovič told reporters on Monday. “I cannot go into [all the] details [about] what was discussed yesterday, but I can assure you it was not only about trade.” The comments come amid deep concern in Europe over the durability of US support for Ukraine, which continues to face escalating Russian attacks more than three years after Moscow’s full-scale invasion. Read more.
Brussels and Washington offered sharply different accounts of the deal’s details. The disagreements include whether some of the EU’s steel and aluminium exports to the US will be exempt from Trump’s 50% tariff; the timeline for the imposition of tariffs on the EU’s pharmaceutical exports; and how – or if – Brussels will “streamline” the sanitary certification procedure for American pork and dairy. “There’s plenty of horse trading still to do,” US Commerce Secretary Howard Lutnick told CNBC on Tuesday. Read more.
The eurozone economy grows by 0.1%. The modest expansion in the second quarter of this year represents a slowdown from the 0.6% GDP growth recorded in the first quarter, but exceeded the zero growth predicted by economists in a Reuters poll. Stronger-than-expected results in Spain and France helped offset an unexpected contraction in Italy. Germany – the eurozone’s largest economy, whose export-dependent industries are heavily exposed to US President Donald Trump’s sweeping levies – also shrank by 0.1%, in line with analysts’ expectations. Read more.
Brussels proposes freezing €1.5 billion in EU funds to Ukraine. The move came after Kyiv fell short of implementing reforms linked to tackling corruption and the rule of law. It also came after President Volodymyr Zelenskyy faced rare EU criticism and the first major anti-government protests since Russia’s full-scale invasion in 2022 over sweeping changes to two key anti-corruption bodies. (The changes have since been reversed.) But people familiar with the matter said the suspension of the payout was unrelated to Zelenskyy’s moves. Read more.