Welcome to the Global Rewire podcast. My name is Craig Taus and my co-host is Fabio Nataluchi, Anderson Institute CEO. Fabio, today's guest is watching and directing coverage of one of the most interesting stories in the world right now. How will Europe redefine itself in a time of fragmenting economic and security alliances? Her name is Gina Smeolik. She is Brussels bureau chief for the New York Times. Prior to this assignment, she was the Times Federal Reserve reporter in Washington.
She wrote a book during that period called Limitless, which explored the Fed's expanding role in the financial system. She is working on a new book which we'll get to at the end of the show. And before we get started, I want to remind everybody that the institute is independent. We aren't aligned with political parties. We have no policy agenda. There's no house view. That's important to say. We aren't funded by influence groups or foreign donors. We conduct independent rigorous analytical research and draw our conclusions from the fact. And with that, I think I'll just start like this. Gina, Mario Draghi said raising productivity in Europe is an existential challenge. And now they have a chance. They have to rebuild the defense industry. In the United States, when this happened, we had a lot of really great spillovers. Everything from the internet to laser gyroscopes to GPS. Is there any sign that innovation and defense spending is starting to revive in Europe?
I think it is very clear that defense spending is reviving in Europe. I think the real question is whether that's going to actually lead to this innovation boom that we're hoping for. So it seems pretty clear and pretty obvious that we're going to see a lot of outlays in some of the really cutting edge technologies that have been used in the war in Ukraine in particular. You know, drones, space, space imaging, satellite, these are all the sorts of things that we're talking about every day here in Europe now. But I think the question is can you really harness the full power of all of these billions of dollars really that are pouring into the sector right now and use them efficiently in a way that draws it sort of drives the agenda forward. We're definitely seeing some positive evidence of this I think in places like Estonia which is very high-tech and very much leveraging the lessons learned in Ukraine to sort of drive that tech to sort of new and innovative uses. You're clearly seeing how this could work. But at the same time, Europe has this eternal challenge that it is 27 countries banded together into the European Union, assuming we're talking about the European Union, and they have 27 unique defense sectors. And so, everybody kind of wants to do its own thing. And so I think there's also this real concern and this real challenge here in Europe of trying to harness all of that money and all of that innovation and using it together instead of doing sort of 27 individual sort of brittle projects and the goal is to how do you get this to be a big project?
One point and how to frame this in some sense, right, to get to this pillar that Craig is mentioning, you need an ecosystem. It's a number of things together: includes research, includes academia, includes centralized fiscal spending, includes importantly I think risk capital. You cannot fund this one just with public money, it's not going to generate those spillovers in my view. But even if you think about private capital, you need a different private capital in the sense that you don't need debt, you need equity, you need risk capability. From that standpoint, Europe has been chasing capital markets union, savings and investment union, whatever name you want to use here for decades now. And the speed where you need capital, it's faster than I think the time you need to actually build that ecosystem. So I'm a little skeptical even as a European that you can get those spillovers because ultimately without private risk capital the ecosystem just doesn't work. Am I too pessimistic? I live too long in the US?
So, I think one thing that's been really interesting to me covering this, so I've been covering this beat on and off for about a year and a half now, and when I first started on it, everybody said that you're never going to get venture capital in any large way active in defense sector in Europe because this is an untouchable. Nobody wants it in their portfolio. You know, it doesn't play well with the European public and so there's a huge stigma around defense investment and I think we've really seen that go by the wayside. You know, last year was a really good venture capital year here in Europe actually. It's still extremely small compared to the United States. Like I think the US is something like nine times bigger when it comes to venture capital and defense. But you are finally starting to see some number, some, I think it's something like 9 billion last year was the number that flooded in venture capital in defense and so you know you are seeing some sort of move in that direction again small compared to the US but I think that maybe you are correctly pessimistic that maybe there's like a silver lining or some room for hope at the edges.
I think my concern is like the mentality in some sense, right, the attitude toward risk taking that is one of the main drivers that you need not just defense but innovation all of that and that mentality takes a long time to change and then in addition to that is the barriers within Europe, right, you can't have 27 capital union, capital markets, the sum of those is not additive, it's more than that, that's I think my pessimism on this.
One feature of this new defense though is that it's less capital intensive. Ukraine is kind of capital starved and they're creating great innovations that are the whole point of new warfare is to be cheap, highly kinetic and the only real challenge now is to increase range. So doesn't that make it easier to adopt and do you see any cross fertilization from Ukraine into Europe and partnerships that sort of thing?
So Fabio was actually making a really interesting point to me recently along these lines that not just because Ukraine's been capital starved, but also because as your listeners probably know, there's a giant backlog on defense products, particularly coming from the US. Like you can buy all of the sort of fancy, expensive, really high tech stuff you want right now, you cannot get it delivered. And the war in the Middle East has further delayed that. And so I think there's been this real effort to sort of like bootstrap stuff together to deal with the problems that are surfacing with the Ukrainian war against Russia. And so I think that there has been this real push trying to figure out how to do things in a sort of different way, a cheaper way. The sort of eternal line that everyone uses here is you don't want to use a fighter jet to shoot down a drone, right? It's like a hugely inefficient or like a missile to shoot down a drone because they're hugely inefficient uses of resources and sort of the technology and the sort of nature of warfare has just changed. And so I do think there's probably some hope there. I think at the same time that can be exaggerated because at the end of the day we're all still talking about how you get those Patriot missiles delivered. You know, at the end of the day, you do still need some of that long range capability, high-tech stuff. You know, you still need your F-35s. And so, we're fighting wars that look more sort of spacey, futuristic, high-tech. But some of the bread and butter, hardcore, very expensive defense tech is still really important even in modern warfare.
Do you think Europe is ready to make some tough choices? So, forget the private capital for a second, right? Some of it is going to have to come from public money. There's already large fiscal deficit to GDP including for my own country is significantly high already. At some point there's a trade-off, right? If you invest more in defense, if you invest more in, I don't know, resilient supply chain, something else needs to give here. You need to trade off maybe spending, I don't know, in social programs or you need to reduce spending on other social objectives. Do you think that that discussion reached a level of maturity in some sense that countries are ready to make those choices? Otherwise it's if you just add debt forever it's much easier but I think we're at a point where you need to make hard choices.
I mean I think that discussion is actively happening right now, right? I think you know I cover the Benelux region because I'm in Brussels. I cover the EU, but I also cover the Netherlands and Belgium. And both of those places are having debates over sort of their mix of spending right now as they try and ramp up defense spending. And where those cuts are going to come from and what they're not going to spend on that they otherwise would have spent on. And so to some degree, I think at a national level in the capitals, these discussions are happening. Certainly also at an EU level, to some degree, this discussion is happening. We're currently in a multi-year debate over the next EU budget, which is possibly one of the more painful political processes I've ever covered in my life. But a lot of that discussion centers on sort of the mix and like how do you sort of reprioritize toward the innovation and the productivity and the reshoring manufacturing and investing in defense stuff because all of those things kind of fit together as part of this puzzle but they are obviously not sort of the common agricultural policy that the EU has historically invested a huge portion of the budget in. And so there is this real question about mix and I think you know it's kind of a story of constant agony here and I imagine it will be for some time. I think the sort of you know devil will be in the details. I don't think we're through to the end of the story yet.
There's a feeling sometimes and maybe again I live too far now from there but there's a feeling that every time there's this big decision whether this is defense whether this is now the energy shock coming from the Middle East that's a call for suspending the fiscal rule in Brussels or to firing a new carve out because this is a specific situation. That's the easy part in some sense that helps you in the short term, it's not going to address this issue in the medium term though.
Well so we've clearly seen that already. There have been carveouts for defense. And so I mean I as a longtime economics reporter, I am always hesitant to suggest that deficit spending will not continue in the medium term and that there will not be some future way to become more indebted that we figure out as we continue down this road because in my experience that seems to be the way governments work. You know, I have a mere 15 years of this under my belt, but in that entire period, it seems like people always seem to find a way to make short-term deficit spending the long term or at least the medium term.
You know, Washington has this culture where there's all this mudslinging and fighting and TV interviews, but eventually suddenly something happens and there's a vote and it passes or it fails. What's the sense of urgency in Europe since you're sitting right there with the European Union? Is it endless debates or is there a sense like we have to stop talking and actually do something and move forward with this threat on our east here and a more hostile United States. Quite frankly,
I'm probably going to get hate now for saying this because I feel like it's not a particularly popular take on the EU, but I think they've actually kind of done a lot over the last year in this area. Like I think they've kind of made some moves and not just the EU, but the national capitals as well. And I think for the very obvious reason that they had the huge threat of a possible American pullout from NATO and from sort of defending Europe, supporting the alliance hanging over their heads. But a year ago at this time we were prepping for the NATO summit and everybody was sort of like incredibly well, a year ago but everyone was incredibly nervous sitting on the edges of their seat afraid that the Trump people were going to come and sort of pull out. And instead, what we saw Europe do was really pledge in a pretty aggressive way to get to a slightly fudged 5% on defense spending. And they promised they would do that. And we've seen quite a lot of countries actually getting pretty close. And some of them are moving toward that number very, very quickly. I mean, the Baltics obviously were already headed in that direction even prior to last year. But we've seen other places like Denmark, Netherlands like really making a pretty aggressive effort towards spending more on defense. Germany is a good example that the Trump administration keeps calling out. And so I think we've seen a real ramp up in serious defense spending. I think at the same time we've seen the EU roll out a number of programs that have proven quite popular. I remember last year they unveiled this what they call their SAFE defense spending program which is basically a fancy joint procurement program like it helps countries that want to band together and do some kind of military project do that. And at the time that it came out, everyone was kind of skeptical about whether it would work or not. And now the thing is like oversubscribed. Like everybody wants to use it. There's been a real sort of like rush to get in the door. Hungary has been trying to like get back in good graces so that it can get SAFE money. And so I think there's been a really interesting sort of series of moves that have happened over the last year. And I think there's a lot to be pessimistic about but I think sometimes it gets lost that there has been quite a lot of action.
I mean I think one of the positive and I think we wrote an op-ed on this few weeks ago that if you start summing up all these expenses SAFE and across a number of topics right resiliency defense you get to a number of potential euro bond issuance centralized like one two trillion euros that seems a significant mass in terms of size to actually get momentum behind the euro bond market. And that means more centralized fiscal policy that means that you're really stepping up the game in sense of like the role of Europe. Do you get a sense that this is moving forward that there is this sense that this is a window of opportunity also to push a little bit of more integration for example on the fiscal policy side?
We're certainly getting more integration on this specific part of fiscal policy. I think one thing that's been really, I'm going to kind of answer this a little tangentially, but one thing that's been really interesting about this discussion is the way that we're getting integration, not just amongst EU members, but also with what people sometimes affectionately call the EU plus. Like you see a lot of collaboration right now on defense issues with Norway, the United Kingdom, and Canada. Canada, the almost EU member that just doesn't quite geographically fit. And so I think that there's been a really interesting push to sort of expand the friends and family and, you know, bring them into this project. And that integration has been really interesting because I think there's this real, I mean it's got some of the sort of middle powers unite energy that Mark Carney has been talking about, but it's very specifically on this issue of defense and how do we make sure that we're prepared in a world where we've got some of these sort of what sometimes calls predators at the gate. You know, like how do we make sure we've got friends and allies who have our backs and our supply chains when that happens.
I guess following on Fabio's comment, one thing we were touching on in the editorial is can the euro become a more widely held currency as this deficit expands? So, let's put on our monetary policy hats for a minute. Jeanna, you know, is it going to be attractive to hold and will people want to hold it? And this gets to Draghi's appeal to more productivity and making it a good place to invest. What do you think?
I think any economist or expert or possibly even policy maker here would tell you that this is one of the big challenges facing Europe. I don't think they've cracked this at all. I think that having a more integrated capital market and really sort of walking the talk when it comes to broader integration across the 27 member states is something that they still haven't fully figured out. And that's probably a necessary precondition to having a euro that plays a larger role on a global stage. Certainly one that challenges the dollar. I don't think they think they're close. So, I mean, there are things that they're doing around the edges when it comes to financial regulation and when it comes to digital currency innovation that I think they think could help. It's not the kind of thing that people are walking around Brussels saying, you know, just wait. Everybody's about to fly to the euro, you know. I mean despite the fact that you know I do think that global turmoil and sort of the reordering of the global political order can sort of have some potentially beneficial effects for the euro as a reserve currency. You don't see people saying that you know this is the euro's big moment and it will forever change its role in the global monetary system.
Yeah. So, I lost that argument with Fabio and you, it seems.
I didn't say a word. I was quiet for once.
We had a big debate before the podcast. Would things like, you know, solid digital asset laws, a digital euro, would it increase euro holdings? And I think Fabio's answer is nah.
Before you go into the way you hold assets, right? Whether this is fiat, whether this is digital, there needs to be demand for those assets. Otherwise, digital is just a way to hold them. And so I need to be convinced that there is this like surging demand for euro assets here. And then it boils down to AI and innovation. It boils down to capital markets. It boils down to productivity. Ultimately those are the main fundamental drivers why you hold different assets and digital is just another way of holding them and so I don't think digital is going to generate demand just because it's digital and it looks cooler and younger. You need some fundamental reason. Until Europe addresses those issues in my mind, that digital is not going to be the game changer.
And I also think it's worth noting that I think a lot of the digital conversation around the euro and the sort of CBDC central bank digital currency portion of this conversation is really a question like we have kind of talking about multiple things when we talk about money as anyone who spent time with money knows and I think this is actually a payment system issue to some degree. You know I think part of a huge part of the motivation behind that is really about creating some sort of alternative to the Visa and Mastercard and sort of the international payment rail system that is very dominated by non-European firms. I think there's a lot of consternation here around the huge reliance on those kinds of firms especially in light of things like SWIFT sanctions which have shown that those can be really effective ways to put political pressure on European or international entities. And so I think part of this is a geopolitical play as much as it is a financial one.
That's interesting. So there's some opposition to US banks running the credit card systems.
Not opposition, but we need a counterbalance. We need our own payment.
Yeah. It's something that comes up in these conversations for sure. Yeah.
Yeah. That's interesting. I didn't think of that. That was there also when I was in college. So which was many many years ago. This discussion about US banks in Europe and blah blah blah and the differential regulatory approach to it. And that's been a very old discussion in some sense. I think the geopolitics made it more sensitive now.
Yeah. There is more antipathy.
I was talking to a SWIFT official recently if you're sanctioned and you can't use your credit cards, you know, because they run on the US system essentially and I think that that's a relatively new facet to this conversation. Right. One thing Draghi criticizes are what he calls Europe's dominance of middle technologies which is kind of an interesting criticism. One area where Europe does lead is decarbonization and the numbers out of Spain are pretty amazing. I think they had their first full carbon zero day in April and they run about 60 to 70% of the country on renewables. So is this plug and play technology or is it something you know a combination of hard tech and skill that they could export to other places?
