Are Trade Wars an 'Aberration' in an Alliance?

Not always, but this time feels different.

Between last week’s headlines on Iran, the ‘Beautiful Bill’ and New York’s next mayor, the ever-quotable French president raised an issue that should be even higher on every investor’s mind in these days of shifting geopolitical alignments:

"We can't say we are going to spend more, and then at the heart of NATO, launch a trade war," Macron told reporters following the alliance summit that endorsed notional defense budgets at 5% of GDP. "It's an aberration, and that's why it's very important that we can return to what should be the rule within all the allies, that is to say, a true trade peace and therefore lowering all tariff barriers that exist or that have been reinforced.”

It's a reasonable question. Even if it may be appropriate for Europeans to share more of America’s defense burden, why should they also be asked to absorb the costs of trade barriers erected by America itself? And if you’re an investor in a U.S. or European company, how much are the potential risks and returns changing as diplomatic and commercial interests diverge?

Frictions in any family are bound to rise and fall, but any banker will tell you that a couple headed for divorce faces a far more tenuous financial future.

The Atlantic alliance has endured repeated crises. President Eisenhower forced Britain and France to withdraw from their ill-planned attempt to seize the Suez Canal in 1956. There were sharp disagreements – and mass protests – over President Reagan’s decision to deploy short-range nuclear missiles in Europe. And, of course, European opposition to President Bush’s decision to invade Iraq prompted harsh retribution in the conservative American press. (See above - and below.)

There have been plenty of purely selfish commercial disputes within this sacred bulwark against tyranny and central planning. The current differential in U.S. and European tariffs on cars and trucks is rooted in what became known as the “chicken wars” of the early 1960s, when American poultry exports poured into Europe. What European regulators currently describe as efforts to ensure fair competition for digital services look in Washington like unfair attacks on U.S. tech giants.

America’s alliances with Korea, Japan and Australia have certainly survived sharp differences on trade and investment rules. At first blush, Macron’s remarks look like whining in the face of a more vigorous U.S trade policy as an approaching July 9 deadline threatens stiff tariffs.

But the current chapter in the transatlantic relationship feels different.

First, there’s a foundational crack in how the U.S. and Europe view the risks from Moscow. For years, American leaders have warned Europeans not to grow too dependent on Russian energy. Now the tables have turned, and the Europeans believe the Americans don’t fully appreciate Russia’s enduring threat.

Second, on economic issues, the Trump Administration doesn’t just complain about unfair European trade practices. President Trump famously insisted the European Union was created “to screw” the United States. Trade is not mutually beneficial in his book, but rather a zero-sum game in which the other side has been cheating.

Third, and perhaps most important, there’s a real sense of broken trust in Europe. Polls show more Europeans view the United States as a “necessary partner” than an “ally.” Trump left the Hague Summit last week with warm words for NATO, but few want to bet that he will say the same thing next month. Even fewer feel certain that a future U.S. president won’t put the China challenge first and leave Europe to fend for itself.

None of this seems relevant to the current markets, where key indices touched new highs last week. But diverging geopolitical interests inevitably aggravate commercial differences. And vice versa.

Investors now face a period in which tariffs have become permanent and unpredictable features in U.S.-Europe trade. There will be dwindling willingness in Washington or Brussels to resolve disputes over export controls or regulatory alignments. Financial markets will be less than completely certain that the Fed will come to the rescue of European banks that need dollar liquidity in a crisis.

Meanwhile, these differences will make it harder to stay aligned on key security threats in Iran or Ukraine. Few in Europe believe the Iran nuclear program has been permanently resolved with the recent U.S. and Israeli bombings. Trump’s long-term strategy to counter a Russian military threat remains anyone’s guess.

Economic and commercial disagreements are inevitable within the strongest of military alliances, but they are indeed an “aberration” and a danger when one big ally seems to be deliberately trying to make them worse.