What is the cost of the US-EU economic and trade ‘breakdown’? How many more ‘breakdowns’ can the US economy withstand?

Trump’s attempts to annex Greenland and impose tariffs on several European countries have pushed the transatlantic alliance to the brink of crisis. Once a trade war erupts, the U.S. economy could feel the pain—ranging from South Carolina to Silicon Valley.

Many European leaders gathering this week in Davos, Switzerland, for the World Economic Forum are considering countermeasures for the alliance, including imposing tariffs on more than $100 billion worth of U.S. goods and making it harder for American multinational companies to bid on contracts in Europe. For an already stagnating Europe, a trade war would be devastating.

Economists say that tit-for-tat tariff measures may not lead to a U.S. economic recession but could suppress growth, hit an already weak domestic manufacturing sector, and increase costs for consumers and businesses as the U.S. struggles with inflation.

In the long term, deteriorating relations may lead Europe to reduce its reliance on the U.S. and deepen trade ties with other regions, thereby weakening this bilateral relationship that once drove prosperity on both sides of the Atlantic.

Mary Lovely, a senior fellow at the Peterson Institute for International Economics, stated that the ultimate outcome for the U.S. could be declining sales by American companies in Europe, damaged profits, and opening the door to competitors. She said: ‘Once new relationships are established, they are hard to change.’

The U.S. and European economies are deeply intertwined. The EU is the largest trading partner of the U.S. and the largest source of foreign direct investment in the U.S., with $3.6 trillion invested as of 2024. Conversely, U.S. companies generate enormous profits by selling software, financial products, and oil across the Atlantic.

Philip A. Luck, director of the economics program at the Center for Strategic and International Studies, stated, ‘In the realm of trade, there are few relationships deeper than this.’ ‘If you look at the current construction of artificial intelligence and data centers, their funding comes from revenues generated in Europe and elsewhere.’

A trade war is not the only economic risk. Some analysts warn that Trump’s threats against Europe could also lead European investors to cut back on investments in U.S. stocks and bonds, potentially weakening the dollar, depressing U.S. stock prices, and raising U.S. borrowing costs. Higher borrowing costs, in turn, tend to suppress corporate investment and household spending, leading to slower economic growth.

Trump has consistently used America’s unparalleled economic strength as a powerful tool to force allies and adversaries alike to submit to his will. So far, he has largely gotten his way. Europe, which relies on U.S. military support to counter Russia, stands to lose more if relations break down, giving its leaders an incentive to appease Trump rather than retaliate. This was the case last year when the EU agreed to an imbalanced trade deal rather than risk losing U.S. support for Ukraine. But some analysts say it is not certain whether Europe will yield again.

Last Saturday, Trump announced that he would impose a 10% tariff on Denmark, Norway, Sweden, France, Germany, the United Kingdom, the Netherlands, and Finland starting February 1. Trump wrote on social media that if no agreement to sell Greenland to the U.S. is reached by then, the tariff will rise to 25% on June 1. The proposed tariffs would hit a range of European luxury and high-end goods, from French perfumes, cheese, and wine to German cars.

Although transatlantic goods trade has slowed since the 2007-2009 recession, U.S. service exports have continued to expand rapidly. This includes financial, legal, and insurance services, though it is increasingly concentrated in digital services and cloud computing provided by leading American tech companies such as Microsoft, Amazon, Google, and IBM. The European Union remains the largest destination for U.S. service exports, with total service exports to the bloc reaching $294.7 billion in 2024.

Sridhar Ramaswamy, CEO of the U.S. cloud software company Snowflake, stated that every successful tech company derives substantial revenue from regions like Western Europe. ‘Whether it’s regulation or actual tariffs and taxes, I think this will have a significant impact,’ Ramaswamy said in Davos.

Some EU leaders indicated they might delay approval of last year’s trade agreement with the United States (which reduced tariffs on many U.S. exports to Europe) and are considering retaliatory taxation. Economists noted that Europe’s response could be carefully calibrated, targeting U.S. export goods that are both prominent and ‘symbolically important to red states’ to maximize political pressure on the U.S., according to Brad W. Setser, an economist at the Council on Foreign Relations. In past trade disputes, the EU imposed tariffs on bourbon whiskey, Harley-Davidson motorcycles, and agricultural products.

‘Think about high-end consumer goods that Europe likes but can do without,’ Setser said.

As tariff rates rise and European retaliation expands, risks will escalate sharply. Some economists believe that the 25% tariff threatened by Trump, combined with existing tariffs of 10% to 15% in certain industries, may become high enough to halt two-way trade in affected categories.

Economists noted that even without European retaliation, additional tariffs could slightly drag on the U.S. economy in the short term, as they increase costs for American businesses and consumers.

A new study by the Kiel Institute for the World Economy, a German think tank, found that in 2024 and 2025, U.S. businesses and consumers bore 96% of the tariff costs, while foreign exporters shouldered only 4%. So far, tariffs have not led to the inflation surge economists anticipated, and the U.S. economic growth rate reached its highest level in two years—far surpassing that of Europe.

However, the U.S. economy has vulnerabilities. Its manufacturing sector—already under pressure from trade tensions and high interest rates, with some indicators showing contraction—is particularly fragile due to its tightly interwoven supply chains with Europe, according to Lafferty.

Many U.S. factories source machinery, turbines, and components from Europe, and tariffs have increased their costs. If Europe imposes retaliatory tariffs on U.S. goods, manufacturers engaged in transatlantic exports could suffer. ‘This would be another blow,’ Lafferty said.

Regions at the highest risk include Spartanburg, South Carolina. The area hosts a large BMW plant that employs approximately 12,000 people and indirectly supports tens of thousands of jobs across South Carolina. The factory imports some engines and parts from Europe and exports more than half of its production, much of which goes to the EU. Retaliatory tariffs could lead BMW to cut production in the United States, according to Stuart Pearson, head of automotive and mobility research at Oxcap Analytics.

Pearson also pointed out that American automakers are far less dependent on the European market. If higher tariffs hit European car imports and weaken their competitiveness, American automakers may benefit instead. In the long term, tariffs could also attract more foreign companies to set up factories in the United States, thereby boosting manufacturing.

European investors hold approximately $8 trillion worth of U.S. stocks and bonds, ‘almost twice the total of the rest of the world combined,’ wrote George Saravelos, Global Head of FX Research at Deutsche Bank, in a report released last Sunday.

He added, ‘It remains unclear why Europeans would still be willing to play this role in an environment where the geo-economic stability of the Western alliance is being fundamentally undermined.’

This is by no means the first time Wall Street has questioned whether other countries might attempt to reduce their political and financial ties with the United States. Early last year, the Trump administration signaled caution regarding military support for Europe, followed by threats to impose tariffs on global imports, sparking fears in the market about a potential ‘sell-off of the U.S.’ scenario.

These concerns ultimately proved to be overstated. Foreign investors continued to show strong demand for U.S. financial assets last year, with the S&P 500 Index recording double-digit gains for the third consecutive year. U.S. Treasury bonds remain the ultimate safe asset for global central banks and investors, helping the U.S. maintain massive budget deficits without facing a significant rise in interest rates.

Rich Nuzum, an executive at Franklin Templeton Asset Management, stated that the market has learned to disregard Trump’s tariff threats, implying that the new tariff threats against Europe will likely be treated similarly. ‘There was a time when the market really cared about tariff announcements. Now things are different,’ he said. ‘The market believes issues will be resolved. There may be noise, disruption, and fear, but it will eventually pass.’

The most severe economic escalation would occur if Europe were to deploy its so-called ‘Anti-Coercion Instrument’ (nicknamed the ‘bazooka’), which allows it to retaliate against U.S. services and investments. Under such circumstances, the EU could impose higher taxes, intensify regulatory scrutiny, or otherwise restrict American companies operating within Europe.

This would impact industries such as pharmaceuticals. American companies often conduct research and development activities through countries like Ireland, where they produce active ingredients and record profits in low-tax jurisdictions. Tech companies may face similar risks. For instance, Apple, despite manufacturing most of its devices in Asia and selling them globally, still records a substantial portion of its intellectual property and global profits in Ireland.

‘These highly profitable global companies have significant operations in Europe,’ said Setser from the Council on Foreign Relations. He added that if Europe targets this point, it would mean a decline in the global profits of U.S. companies, weaker stock market valuations (especially for tech stocks), and reduced investment capacity in areas such as artificial intelligence.’