Time for the US to calm Europe’s troubled economic waters

As Shakespeare might have put it, economic troubles have now come to the European economy not as single spies but as battalions. This must make it in the United States’ own economic interest to seek to calm Europe’s troubled economic waters rather than to stir those waters by threatening Europe with the imposition of automobile import tariffs and by cheerleading for a hard Brexit.
Anyone who doubts that the US-China trade war is having a negative impact on the highly export-dependent German economy has not being paying attention to the Bundesbank’s recent warnings that the German economy is likely already in recession. Nor have they noticed that the whole of the German government yield curve is in negative territory and that even 30-year German government bonds now offer negative yields.

Anyone who might be entertaining the view that the United Kingdom crashing out of Europe on October 31 will be an economic non-event have not been paying attention to the Bank of England’s warning about the consequences of a hard Brexit. According to the Bank of England, within a year or two of a hard Brexit, UK output is likely to decline by as much as 5 percent relative to where it would otherwise have been.

Sadly, Boris Johnson is substantially increasing the prospect that the UK will soon crash out of Europe. He remains adamant that the UK will definitely leave Europe on October 31 with or without a deal, and he insists that the vexing issue of the Irish backstop be dropped by the Europeans as a precondition for any future Brexit negotiations despite knowing full well that this request is a non-starter for the Europeans.

Adding to Europe’s economic troubles now is Matteo Salvini’s successful effort to bring down the Italian government. This raises the specter of early Italian elections and of Mr. Salvini soon coming to power. The last thing that a heavily indebted Italian economy that is already in recession needs is a prolonged period of political uncertainty. And Italy can hardly afford the prospect of a government led by Mr. Salvini, who has long been highly critical of Europe and has toyed with the idea of introducing a parallel currency for his country.

With the European economy in such trouble and with that trouble now casting a dark cloud over the global economic outlook, it is difficult to understand why the Trump Administration would want to add to Europe’s economic woes. Yet that is what President Trump is doing by threatening Europe with import tariffs on its automobiles and by taking the European Central Bank to task for responding to Europe’s economic weakness by loosening monetary policy. It is also what John Bolton is doing by encouraging Boris Johnson to crash out of Europe with the illusory promise of a quick US-UK free trade agreement.

Hopefully, the Trump Administration will soon come to the realization that a healthy European economy is vital for both for US and global economic prosperity. If not, we should brace ourselves for a turbulent time in the global economy in the year ahead that will all too likely reach our shores.

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and the multilateral lending agencies.