Europe’s “State Of The Union”: A War Economy, Without The Guns To Support It

By Michael Every of Rabobank

Ursula von der Leyen gave a muscular State of the Union address yesterday. There was no shirking from the outset: “Never before has this Parliament debated the State of our Union with war raging on European soil….From that very moment, Europeans neither hid nor hesitated. They found the courage to do the right thing.” Some of the right things, as critics even within the EU might point out, and much slower and on a much smaller scale than the US, for example.

There was a clear warning: “The months ahead of us will not be easy. Be it for families who are struggling to make ends meet, or businesses, who are facing tough choices about their future.” Europe was about to be tested, she said, and much was at stake, for it and the world at large. But that was about all she said about the tough choices or struggling from then on.

VDL opted for geopolitics over economics: “This is not only a war unleashed by Russia against Ukraine. This is a war on our energy, a war on our economy, a war on our values and a war on our future. This is about autocracy against democracy.” That sounds very much like the economic war and systemic metacrisis warned of here all year, and which touches just about everything.

She stressed that Russia’s financial sector is on life-support and “Nearly one thousand international companies have left the country. The production of cars fell by three-quarters compared to last year. Aeroflot is grounding planes because there are no more spare parts. The Russian military is taking chips from dishwashers and refrigerators to fix their military hardware, because they ran out of semiconductors. Russia’s industry is in tatters.” It isn’t the only one facing that fate, sadly: regardless, “I want to make it very clear, the sanctions are here to stay.”

EUR100m was offered to Ukrainian schools: a down-payment on the estimated EUR300-400bn it might take to rebuild the country. Then VDL pointed out the EU has connected Ukraine to its electricity grid: “And today, Ukraine is exporting electricity to us. I want to significantly expand this mutually beneficial trade.” I am sure Europe would love more electricity from Ukraine, though it is odd that a shattered country should have to do that kind of lifting.

She stayed geopolitical, via energy: “We should have listened to the voices inside our Union – in Poland, in the Baltics, and all across Central and Eastern Europe,” and spoke of new investments in renewable energy, LNG terminals, and interconnectors, noting “This costs a lot. But dependency on Russian fossil fuels comes at a much higher price.”

“Gas prices have risen by more than 10 times compared to before the pandemic. Making ends meet is becoming a source of anxiety for millions of businesses and households.” Yet that pain has only just started to be felt. It remains to be seen if her assertion that “Europeans are also coping courageously with this” will remain true, as she offered Stakhanovite stories of ceramics factories in central Italy that have moved their shifts to early morning, to benefit from lower energy prices. Such sacrifice! But any others are just going to close completely. Indeed, although VDL proclaimed that “We were in the deepest recession since World War 2. We achieved the fastest recovery since the post-war boom,” some now fear the deepest recession since World War 2 all over again, especially as US shale warns Europe that it won’t be able to step up to fill demand gaps this winter.

Indeed, as France capped energy price hikes at 15%, VDL proposed electricity rationing, without details of how; she merely added that defraying the higher bills that are looming with windfall taxes and revenue caps: so where does the capital come from to invest in all this new energy supply? No answers. The TTF gas market will also be shaken up to establish a more representative benchmark – based on what?

The EU will also now take into account the specific nature of its relationship with energy suppliers, labelling them in a ‘traffic lights’ system from unreliable to reliable: and what if many are red or amber, given Europe has not yet gone green? VDL acknowledged the EU is short of the metals it needs for that transition, and that “almost 90% of rare earths and 60% of lithium are processed in China.” In response, she announced a European Critical Raw Materials Act, which will identify strategic projects all along the supply chain, from extraction to refining, from processing to recycling, and build up strategic reserves where supply is at risk. Many of us can point to where all this green stuff is on a map; and who owns the mines; and which direction the commodities flow; and how rough this Great Game is on the ground. It’s doing something about it that is hard and expensive.

Apparently all is well though, as VDL noted: “Five years ago, Europe launched the Battery Alliance. And soon, two third of the batteries we need will be produced in Europe.” How soon? And what energy source will be powering all this cars switching from oil? She also boasted: “Last year I announced the European Chips Act. And the first chips gigafactory will break ground in the coming months.” So, years from completion. And what energy will be powering it, as at least one EU national leader worries about “de-industrialisation”?

Then it was back to values: “This watershed moment in global politics calls for a rethink of our foreign policy agenda. This is the time to invest in the power of democracies. This work begins with the core group of our like-minded partners: our friends in every single democratic nation on this globe. We see the world with the same eyes. And we should mobilize our collective power to shape global goods. We should strive to expand this core of democracies.“ VDL will find most of the countries selling most of the green goods the EU needs most are not democracies. And note her pledge that: “I want the people of the Western Balkans, of Ukraine, Moldova and Georgia to know: You are part of our family, your future is in our Union, and our Union is not complete without you!” Russia will love that. So will China.

VDL also spoke of the Global Gateway investment plan announced in last year’s SoTU. Apparently this has already built two factories in Africa to manufacture mRNA vaccines: two. Not quite the Marshal Plan. Indeed, the scheme “requires investment on a global scale, so we will team up with our friends in the US and with other G7 partners to make this happen.”

Then there was another geopolitical message: “We should not lose sight of the way foreign autocrats are targeting our own countries. Foreign entities are funding institutes that undermine our values. Their disinformation is spreading from the internet to the halls of our universities… These lies are toxic for our democracies. Think about this: We introduced legislation to screen foreign direct investment in our companies for security concerns. If we do that for our economy, shouldn’t we do the same for our values? We need to better shield ourselves from malign interference. This is why we will present a Defence of Democracy package. It will bring covert foreign influence and shady funding to light. We will not allow any autocracy’s Trojan horses to attack our democracies from within.”

In short, the SoTU sounded like a Cold War-era US equivalent – without the guns behind it. What the EU is promising is not just a semi war/planned-economy from energy and green supplies up, but muscular liberal-democratic mercantilism from the top down. Such a policy shift was 100% predictable years ago (in this Daily!) without the help of dialectical materialism; all one needed was realpolitik, materialism, and the empiricism of why we had empires and “-isms”

The problem is the EU doesn’t have the muscles to match yet. Indeed, VDL failed to address the full scale of the multidimensional challenges, and sacrifices, the EU will face if it is to thrive in a realpolitik world. The energy crisis will rage for years, with untold pain and at unknown cost: and Europe will simultaneously have to rearm, even as its industrial production will slow. Indeed, as she was speaking, Armenia and Azerbaijan slipped closer to war, the former calling on Russia for help, the latter likely on NATO member Turkey. Shortly after she spoke, Ukraine proposed the EU and US should offer it defence guarantees without NATO membership – and Russia responded that implied a nuclear holocaust.

It may have been expected, and necessary, for VDL to have been ‘laying down the law’ in the way she did: but if you want to be sheriff then you have to accept that there are real bad guys out there, and High Noons. “Long live Europe”, as she concluded – but not by denying that fact.

VDL wasn’t alone in that deliberate oversight though. Markets slept through the whole SoTU as if none of this matters, is already priced in, or won’t happen. The main action was instead the BOJ threatening to intervene to prop up JPY at the same time as the government announced a new fiscal stimulus program – policies that lean in entirely different directions.

Japan (and Australia and New Zealand) echo Europe’s experience of waking up to a cold, harsh, more lawless geopolitical world, and thrashing around for a policy framework that matches.