For much of this year, we've been talking about Europe's doom loop.
Let's talk about how it's playing out.
This "doom loop" is the self-reinforcing loop that, given a catalyst, begins an acceleration toward another sovereign debt crisis in Europe.
And there hasn't just been 'a' catalyst. There has been a flurry.
From tariffs, to a defense crisis, to an energy shock.
The latter has exposed Europe's energy dependence. That has resulted in soaring energy prices, which raises inflation. Inflation forces higher interest rates. Higher rates mean a higher cost of government borrowing. Rising borrowing costs weaken the economy, which makes servicing bloated government debt in the weak spots of Europe more difficult. And that results in higher borrowing costs.
That spiral is underway.
What stops it?
In 2012, it was the big and bold threat by Mario Draghi (then President of the European Central Bank) to be an unlimited buyer of European sovereign debt. The threat alone was enough to stabilize the bond markets, stop the loop, without even buying a single bond.
But times are different.
The ECB still wields the threat. The question is, will they be challenged by the market to follow through on the threat? If so, it's unlikely that they will have the firepower to back it up.
Why? Because they will need the support of the Fed, at the very least, to ensure European banks have ample access to U.S. dollars (which they will need in times of stress).
But as we've discussed over the past seven months, this is where the Warsh-led Fed (and Trump's Treasury) can apply conditions to get that support — policy and alignment conditions that European leaders have been unwilling to agree to, to this point.
Trump has restored American leadership in the world. He has used the leverage of the American consumer to reset global trade, and he has reversed the anti-growth climate agenda in favor of energy abundance.
Europe's leaders have resisted. They went all-in on a climate and social agenda over the past decade, and they haven't been willing to abandon it.
The price of that resistance is the doom loop.
So, Europe now pays more than nine times what America pays for natural gas. And the bond market has been pricing it. France now pays nearly 1.5 percentage points more than Germany to borrow, close to the widest gap since Europe's debt crisis in 2011 and 2012. Italy's borrowing costs are climbing with it.
And now it's showing up on the ground.
On Saturday, more than half a million people marched across France over the cost of living and failing public services. Tonight, parts of Paris are under curfew.
France is being squeezed.
Meeting demands for more public services costs money. That means more debt, which drives borrowing costs even higher. Cutting spending to stabilize the debt means more unrest.
With all of this, on Friday, Moody's reviews France's credit rating. It has already warned it may cut it. A downgrade would make France's borrowing more expensive still (accelerating the doom loop).
As we discussed in July, the end game of the doom loop is political change. And political change is probably the only way alignment happens.
