The Economic Costs of Persistent Geopolitical Threats
Summary
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Nearly all panellists (97%) thought that the economic costs of persistent US geopolitical threats are either moderate or large. 47% thought costs are large while 50% thought moderate. Only one panellist thought the costs are small.
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A majority of panellists thought that the cost of geopolitical risks primarily operates through policy uncertainty (66%) and economic and financial fragmentation (66%). A third (33%) of panellists flagged policy distortions as a primary channel, while only 15% cited higher risk premia. Panellists also highlighted the cost of higher defence spending and the erosion of global cooperation.
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The panel was split over the size of the risk that the United States could use its financial leverage against Europe and the UK. 31% of the panel viewed the risk as large, 38% as moderate, and 31% as small.
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A large majority (88%) of the panel expressed scepticism regarding the EU or UK’s ability to use financial leverage against the United States. 50% of panellists thought the threat to use financial leverage was not credible while 38% deemed it as credible only at high economic cost to the EU and UK. Only 13% of panellists deemed the threat credible.
Question 1a: How large are the economic costs to the UK and EU of operating under persistent US geopolitical threats (even when concrete actions such as tariffs are ultimately avoided)?​​​​​​​​​​
Thirty-two panellists responded to this question. Nearly all panellists (97%) thought that the economic costs of persistent US geopolitical threats are either moderate or large, with 47% deeming the costs as large and 50% as moderate. Only one panellist thought the costs are small.
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Question 1b: Through which channels do these costs primarily operate? (select up to two)
Thirty-two panellists responded to this question. A majority of panellists thought that the cost of geopolitical risks primarily operates through policy uncertainty (66%) and economic and financial fragmentation (66%). A third (33%) of panellists flagged policy distortions as a primary channel, while only 15% cited higher risk premia. Of the 19% of panellists that selected “Other”, many highlighted the cost of higher defence spending and the erosion of global cooperation.
Several panellists highlighted the costs of decreasing one’s vulnerability to the United States. A common point raised was one of higher defence spending. Nicholas Oulton (LSE) remarked that “rising defence spending will be at the expense of (non-defence) investment and hence will hit growth.” Jurgen von Hagen (University of Bonn) highlighted the political cost of defence spending, stating that “the need for more military spending of the UK and the EU countries will force cutbacks in social spending which will add to political tensions within these countries.” In a similar vein, Paul Mortimer-Lee (NIESR Fellow) noted that “the problem for Europe is how to fund an increase in defence of 2 to 3 % of GDP given high debt and high social spending . The ‘European model’ must change. That will be politically disruptive. There will tensions between high defence spenders and low (e.g., Italy and Spain).”
Another theme among panellists was the inefficient and persistent consequences of the new global environment. Ricardo Reis (LSE) argued that the United States is operating as a “rent-extracting large player with power” which “deters investment, trade, and generally lowers welfare significantly.” David Aikman (NIESR) noted that “the issue is not that the world has suddenly become more uncertain, but that uncertainty is now policy-generated. Institutions designed to absorb shocks have become sources of them. I expect we'll see irreversible effects on supply chains, investment decisions, risk management etc. The macroeconomic costs are therefore likely to show up in persistently weaker investment, productivity and potential growth, i.e., medium-term effects.” On the persistence of costs, Morten Ravn (UCL) noted that “there are short run costs due to uncertainty, but [the] long run impact through fragmentation is likely going to be more important.” Ramon Marimon (European University Institute) pointed out that “moderate [costs] does not mean they are not important since they are more likely to persist than large disruptions.”
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Panellists also commented on the international relations held by the EU and UK. Jagjit Chadha (University of Cambridge) noted that “correcting our international relationships are paramount” and that the task ahead is one of “re-orientating European policies towards the creation of large important bloc that can stand up to the USA, China and Russia – as well as the emerging strength of India and Brazil.” Thomas Sampson (LSE) recommended that “the UK and European countries should seek ways to decrease their vulnerability to the US, by reducing military dependence and diversifying trade and investment relationships.”
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Question 2a: How large is the risk that the United States could use its financial leverage over Europe and the UK (for example via dollar liquidity, payment systems, or the Treasury market) in a way that would have material economic consequences?
Thirty-two panellists responded to this question. The panel was split over the size of the risk that the United States could use its financial leverage against Europe and the UK. 31% of the panel viewed the risk as large, 38% as moderate, and 31% as small.
Commenters were similarly split on whether the United States would use its financial leverage. The panel highlighted vulnerabilities in times of crisis. Paul Mortimer-Lee (NIESR Fellow) argued that “in any crisis, dollars will be in short supply. The US will use its leverage in supplying the main international means of settlement to get economic concessions.” David Aikman (NIESR) and Morten Ravn (UCL) identified FED swap lines as a vulnerable channel, with Ravn noting that a financial crisis with no FED swap line “could be very costly for those that do not have an alternative swap line with the ECB.”
Other panellists thought that the US track record pointed to a willingness to use financial leverage. Lukasz Rachel (UCL) argued that the US has been “acting on hate and caprice” toward Europe which “creates inherently unpredictable and fragile environment which can get out of hand at any point.” David Cobham (Heriot-Watt University) noted that “Trump has no scruples about using any possible weapon to 'win'” and that “TACO has been exaggerated”. Ricardo Reis (LSE) made the more general point that the use of financial leverage is a large risk because “a highly indebted nation and government will be very tempted to engage in financial repression: extract resources from the creditors.”
A number of panellists downplayed the risk of financial coercion by the US. Jagjit Chadha (University of Cambridge) argued: “Given the quantity of US assets and bonds held by Europeans any such move would at best result in a Pyrrhic victory and ought not to be rationally entertained.” Similarly, Michael Wickens (University of York) commented: “The financial system is dominated by the private sector and it’s not in its interest to disrupt it. The US government needs a stable bond market.” Thomas Sampson (LSE) pointed to recent history and noted that “on the one hand the administration is hostile to Europe in many areas and is willing to weaponize interdependence. On the other hand, signs of stress in financial markets have caused the administration to back-off previous threats.”
Question 2b: Is the threat by the EU and/or the UK to use financial leverage - including asset reallocation, regulation, or restrictions on market access - economically credible?
Thirty-two panellists responded to this question. 50% of panellists thought the threat to use financial leverage was not credible while 38% deemed it as credible only at high economic cost to the EU and UK. Only 13% of panellists deemed the threat credible.
Panellists highlighted that, despite having means to do so, exacting financial threats could be self-defeating, particularly given the necessary participation of the private sector. On the options available to the EU and UK, David Aikman (NIESR) stated: “European investors and governments hold $10.4 trillion in US equities, $3.4 trillion in Treasuries, and $2.9 trillion in US corporate bonds - any rapid exit would trigger massive mark-to-market losses on these holdings before inflicting pain on the US. The flow dimension offers more theoretical leverage: with US deficits exceeding $2 trillion annually and trillions in debt needing refinancing, UK/EU withdrawal from new auctions could meaningfully tighten US funding conditions.” However, Aikman warned that “the coordination problem remains insurmountable - most holdings are private, and attempts to force reallocation would destroy confidence in European capital markets.”
Thomas Sampson (LSE) argued: “There are many ways Europe could bring economic pain to the US and, perhaps more importantly, to business leaders with ties to the Trump administration. For example, through targeted sanctions, market access and travel restrictions, and taxes on European-derived income. Reducing intellectual property protections for US companies would also be an area where Europe has leverage. But all these options would also impose costs on Europe and increase the likelihood of further escalation by the US.”
Jagjit Chadha (University of Cambridge) suggested that divestment from the US may happen without policy intervention, arguing: “It is more likely that fund managers will observe greater risk in the US and prospects for slower growth and consequently, reduce their exposure to US assets – which are high anyway. So we might see a necessary and orderly adjustment.”