For decades, the rest of the world, especially China and countries in Europe, have produced much more than they have consumed, selling goods to America in exchange for an ever-growing pile of U.S. dollars. This could happen because the United States consumes much more than it produces, gobbling up the difference in the form of persistent trade deficits, and financing those deficits with debt, which Chinese and European investors are happy to buy.
President Trump is unwilling to accept this state of affairs. His administration has accelerated a shift to what my colleagues and I at the investment management firm Bridgewater Associates call modern mercantilism: the view that trade deficits are a threat to national wealth and strength.
Mr. Trump and many of his supporters believe that persistent trade deficits have made America dangerously dependent on other economies, put national security at risk and undermined stable middle-class work. That’s the primary reason he is imposing tariffs and adopting other policies that are in the headlines today.
While modern mercantilist policies are meant to counter all American competitors, they pose a particularly severe threat to Europe’s economic engine. If the United States is unwilling to continue to run big trade deficits, it means that the “pie” available to everyone else to produce more than they consume is shrinking.
But this challenge could finally push the region toward urgently needed change and economic revitalization. After Mr. Trump’s recent actions and comments on Ukraine, Europe has abruptly realized that it can no longer rely on the United States for security; the region needs to acknowledge that it can’t rely on the U.S. for economic stability, either.
The United States has the upper hand in this trade conflict precisely because it currently runs large trade deficits. It has more imports to tariff than exports, and it has more to gain should American companies respond by increasing domestic investment and bringing supply chains back home.
This is the opposite of its positioning during the Great Depression-era trade war, which began with the Smoot-Hawley Tariff Act of 1930. The United States was the one running a trade surplus at the time, so it was more vulnerable to tariffs and protectionist measures.
As tariffs ramp up, every country running a surplus with America will find it harder to sell its products in the United States, but those in Europe will suffer most, because their most important industries are exactly those where China has built the biggest advantages.
China has held modern mercantilist beliefs for decades and has for many years used the instruments of government to subsidize industries that it considers strategically important, taking huge losses along the way. At times, it has supported production well above the level of demand in the marketplace.
After decades of government-supported technological advancement, China is a strong competitor in a wide range of sectors: cars, advanced industrial machinery, electrical equipment and appliances; not to mention fields, such as artificial intelligence, that Chinese policymakers prize. As a result, Chinese companies are well positioned to grab the biggest piece of the available trade surplus pie.
Europe, on the other hand, will find itself increasingly squeezed, with the United States unwilling to absorb what it produces and China competing against it in Europe and in whatever smaller countries remain that are still open to exports.
The European auto industry is already feeling this squeeze. Foreign electric vehicle manufacturers have upended the market, particularly Tesla and Chinese companies like BYD, both of which were supported by varying levels of government industrial policy until they became profitable. European governments, however, have been hesitant to follow the same path and funnel public money to private industry; they are caught between a desire to protect their own automakers from Chinese competition and the fear of losing access to the Chinese market if China reciprocates with protectionist measures.
The threat to Europe’s auto industry is existential; investors’ views on these companies are so pessimistic as to imply they may lose the battle to survive. If stock prices continue on this downward trajectory, the economic pain from knocking out such an important industry will expand to the rest of the economy, ramping up pressure on European leaders to adopt protectionism and competitive industrial policy.
While the pressure to protect these legacy industries will be intense, it will be a colossal mistake if Europe fails to simultaneously address what made its economies so vulnerable in the first place: slow productivity growth and weak innovation. China built itself into a competitive powerhouse through technological disruption (in part government supported), while the United States has handily outperformed Europe in technological innovation and productivity growth over the past decade. For example, California has produced more than a quarter of the world’s “unicorns” — young companies valued at over $1 billion — while Germany, an economy of roughly the same size, has produced only 2 percent.
Europe has lagged behind the United States thanks to its fractious and duplicative regulatory system, particularly in the tech sector, and rigid labor markets that make it hard for companies to hire and fire workers.
These problems are well known. In 2024, the European Union released a sobering report on its competitiveness, led by the former Italian prime minister Mario Draghi, that was unsparing in its criticism and forceful in its recommendations for change.
Some of its proposals, such as nearly $900 billion of public investment in sectors like technology and defense, could be transformative, addressing some of the most acute barriers to productivity and innovation in Europe. So far, European policymakers have been slow to execute the Draghi report’s recommendations, despite widespread calls to move with urgency.
The continent’s security crisis may finally be galvanizing action. Germany has taken a essential step and forgone self-imposed constraints on fiscal policy to make meaningful investments in defense. The question is whether Europe will take this opportunity to more broadly transform its economy — and whether its leaders will realize they have no other good choices.
