Similar to Luke Skywalker taking a sigh of relief after successfully striking the Death Star, traders all around the world took a deep sigh of relief when the threat of the tariffs’ laser beam pulverizing their wealth did not materialize after a long weekend of “Black Monday is coming!” fear-mongering across social and mainstream media. How did the Wall Street rebels manage to defuse the threat of US tariffs? They simply started to rationalize the situation rather than approaching it like crybabies who got their pacifier taken away, as was their first reaction last Thursday. As a consequence, a “new hope” quickly started to materialize.
Traders, who now no longer question President Trump’s determination, started to gauge the odds of countries coming to the negotiating table and finding a compromise with the US administration. For Japan and Taiwan, it didn’t take long to beg for Trump’s mercy, which should not surprise anyone anymore. On one side, there is a country with deep and worsening socioeconomic problems, with industrial and financial sectors already on life support, with national champions like Nissan or Norinchukin Bank fighting to survive. On the other side, there is a country that almost entirely relies on one single company to keep its economy going (TSMC), and anything that impairs its operations will have a direct and significant impact on Taiwan. As a consequence, both Japanese and Taiwanese stocks are seeing supporting bids coming back on Tuesday morning.
The situation with the European Union is far more complicated, with some countries willing to come to terms with Trump while others are still openly antagonizing the US president. Germany, which is no longer the locomotive of the European economy but is still the biggest economy in the union, isn’t just going through an economic recession that started years ago, but is, in fact, going through an existential crisis that is threatening to reshape the entire economic structure the country has relied upon since post-World War 2 reconstruction. The German automobile sector, for example, once the crown jewel of Europe’s industrial powerhouse, is in a profound crisis marked by structural decline, technological lag, and eroding global competitiveness. Central to this turmoil is the industry’s struggle to adapt to the electric vehicle revolution, compounded by high costs, policy missteps, and fierce international competition. This downturn is starkly illustrated by Volkswagen, Europe’s largest carmaker, which announced plans to cut tens of thousands of jobs and close multiple factories in Germany—a symbolic blow to a nation where automotive manufacturing accounts for 17% of exports and employs 770,000 people. The sector has already shed 46,000 jobs between 2019 and 2023, with projections warning of an additional 140,000 losses by 2035 (projections without taking into account the impact of US Tariffs). Structural inefficiencies further compound the crisis. German automakers face labor costs 30% higher than global peers, driven by generous healthcare benefits and vacation entitlements, which erode profitability in an era of tight margins. Overcapacity is another critical issue: Volkswagen, for example, employs nearly double the workforce of Toyota despite producing a similar number of vehicles annually, highlighting systemic inefficiencies. The industry’s decline reflects deeper structural flaws in Germany’s economic model, which historically relied on cheap Russian energy and Chinese demand that isn’t there anymore. All I have described so far was the situation in place even before new US tariffs came into the picture.
At this point, it doesn’t take a master’s degree in economics to understand that Germany won’t be able to meet all of Trump’s demands, and because of its still tight grip on the European Union, it will also impair the ability of other countries to find compromises with the US administration and gain a commercial competitive advantage against Germany. Unlike China, which we will discuss in the next paragraph, Germany cannot afford to be shut out of the US market even for a temporary period because the repercussions on its economy won’t be temporary, but deep and long-lasting since industrial plants will start to be shut down to quickly decrease operating costs and cash burn. Once an industrial plant is shut down, it cannot be turned on again like a light bulb; it takes months, if not years. However, Germany cannot afford to meet all US demands either because the consequences on its increasingly less internationally competitive industrial sector will be likewise brutal. How is this going to end? My expectation here is for Germany to agree to use a portion of the 1 trillion EUR budget planned to rearm Europe to buy US-made weapons rather than produce all of them locally as is currently planned. This move will benefit Germany the most because even if it is going to buy time for the whole EU, it will give reeling German companies the chance to restructure and regain competitiveness in the international market so they won’t need strong economic protectionism to survive anymore in the future.
Unlike Japan and the EU, China can instead negotiate from a position of strength. Why? While Chinese exports to the US only account for 3% of China’s GDP, US direct imports from China account for 13.4% of total US imports. Furthermore, there is an indirect dependence with countries like Mexico and Vietnam, which themselves source on average ~30% of their inputs to manufacture finished goods then exported to the US from those countries. Additionally, the US’s biggest company by market capitalization, Apple, has most of its supply chain physically in China, and China also accounts for almost 20% of Apple’s total revenues. Imagine the amount of damage to the US financial system if China decides to pull the plug on Apple, a move that will have negligible impact on its own local economy. Personally, I don’t think this is going to happen anytime soon because the company is already being damaged by the new US policies in favor of China, and such a move might prompt other foreign companies to rethink their supply chain structures in the long term to mitigate the risk of becoming the sacrificial lamb in economic disputes against China. Clearly, on this front, the dispute between the first and second economy in the world will hardly be solved in the short term and will drag on for quite some time, but the longer it goes on, the greater the damage to the US economy rather than the Chinese one, paradoxically. Does the US have any powerful bargaining chip it can use as a last resort against China? Yes, it does, and it is the amount of US Treasury foreign reserves China still holds. However, confiscating those reserves in the same way it was done with Russia will undermine even more the confidence of other countries to hold foreign reserves in USD, and such a move done only on economic grounds will be equivalent to stealing, prompting more and more countries to diversify their reserves away into other assets like gold and ultimately undermining the status of USD as the global reserve currency.
With regard to the situation between China and the US, I expect the ultimate compromise will be found with China’s commitment to investing a significant amount of money to bring into the US part of the industrial production that will then serve the US local market, with the pledge of keeping those profits onshore and reinvesting them in US Treasuries, for which the US needs a significant and higher bid in the future in order to refinance its giant debt without the cost of it going through the roof.
The impact on stocks of all I have described today is, of course, not going to be homogeneous, but it will surely increase the level of uncertainty in markets, and higher uncertainty means higher volatility that translates into higher risks overall in the system. This will make it harder and harder for traders to hold stocks at very expensive valuations, and the consequences will be the ones I described in my latest podcast, “STOCKS ARE NOT CRASHING YET, BUT JUST DETOXING“.
I expect European stocks to be hurt the most since the narrative of “European stocks do not reflect the state of the European economies because companies make most of their revenues abroad” will be hard to embrace going forward, especially for German stocks, considering all those revenues outside the EU are now under significant threat. Japan will remain reliant on BOJ constant money printing, but its effectiveness is clearly fading through time while the costs of perpetrating it are becoming greater and greater for the Japanese to pay through inflation. The impact on US stocks overall will be mixed, but with the major indexes greatly skewed by the performances of companies like Apple and Nvidia, it is wise to factor that the impact of reconsidering future revenues and valuations to lower levels will be a burden for the overall market for quite some time. Chinese stocks, which already trade at fair valuations miles away from the ones still priced in Europe and the US, won’t see more downward pressure at this stage but they will surely react negatively if US actions on global GDP slow down the world economy overall.
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