It has been an extraordinary few days for Washington’s economic and security relations with the world. On January 17, President Trump threatened 10-25% tariffs on 8 European countries if they did not agree to the U.S. executing a “complete and total purchase” of Greenland. This then led to a furious response that united most of Europe, and a subsequent “framework for an agreement” negotiated at Davos that seemed to reflect deescalation on all sides.
But even if this particular storm may have passed with some kind of fudge that offers less than what Trump demanded, the episode raises a fresh round of questions about the increasingly tangled (and contradictory) economic, financial, and security connections between the U.S. and its allies, particularly those in the North Atlantic.
At the heart of the issue is a desire in Washington to use trade links, particularly access to the U.S. market, as a means to achieve security gains, and a simultaneous desire to use security linkages to achieve economic goals. For example, while Trump recently threatened tariffs on EU members to back up his plans for Greenland, many reports suggest that the EU’s decision not to retaliate against U.S. reciprocal tariffs like those levied last year was grounded in Europe’s need for Washington’s military and intelligence assistance for Ukraine.
This is a tactic that has worked until now, but a desire in Washington to weaponize security-economics-finance linkages could not only backfire if pushed too far, but also lead to an unstable balance of financial terror and a threat of Mutually Assured (financial) Destruction. And over the longer term, it is likely to lead to efforts by other countries to hedge, and to gradually reduce both their geopolitical and financial exposure to the U.S.
The threats to Greenland led to a flurry of commentary on how European entities could respond by selling U.S. government debt, and to counter-commentary that the sheer scale of European holdings of U.S. assets would force values much lower if they attempted to sell, thus potentially hurting the holders as well. These voices also argued that precipitate asset sales could also push up the euro, making European exports more expensive, hitting growth.
There has also been increasing concern that Washington could choose to weaponize “swap lines” —arrangements where the Federal Reserve lends dollars for a limited period of time to select counterpart central banks in exchange for their currencies. The presumable goal of any threat to deny swap lines would be to increase financial pressure on countries in need of dollars, and force other policy concessions on them.
But what sometimes is overlooked is that while the pressure strategy might work for countries (or electorates) short of dollar assets (as happened recently with Argentina), it could backfire on the U.S. if it is applied against countries that hold lots of dollar assets that might be less liquid, particularly if financial markets are under stress. A desperate need for dollars could force fire sales of illiquid U.S. assets that depress their prices even more, hitting U.S. holders of such assets as well.
Moreover, the global banking system consists of institutions deeply interconnected through webs of complex transactions where they act as counterparties to one another. The default of any single systemically important entity could cascade through the global financial system as the distressed entity’s inability to honor its contractual obligations might then threaten the solvency of every other entity it has contracted with (including American banks).
The Federal Reserve’s awareness of these interconnections is what led to its provision of extraordinary liquidity measures to foreign central bank counterparts during the financial crisis of 2008 and the outbreak of Covid in 2020.
One important takeaway is that while the Fed is indeed the lender of last resort of dollars to the world (because it alone can produce dollars at will), the U.S. has a profound interest in the Fed retaining that role. That is because in many instances, the Fed is lending the liquid dollars to a world that owns lots of illiquid dollar-denominated assets that it might be forced to sell if in distress, with consequences that blow back into America.
The scale of the imbalance between the foreign assets owned by American entities and American assets owned by foreign entities (termed the “Net International Investment Position” or NIIP) is absolutely staggering. As of the end of the third quarter of 2025, foreign entities owned an “excess” $27.61 trillion of U.S. assets more than U.S. entities owned of foreign assets.
That number is roughly 90% of US Gross Domestic Product for 2025, suggesting an immensely lopsided difference between the world’s financial claims on the U.S., and U.S. claims on the world. But paradoxically, the very scale of the imbalance also suggests prudential reasons why it might be unwound gradually rather than precipitously. An overly rapid reversal would likely cause immense damage to both America and to foreign holders of debt or equity claims on the U.S..
However, there are some signs that a more gradual unwind might in fact be unfolding already. There have been reports that some institutional investors in Europe, driven by political, economic, and geopolitical concerns, are reassessing their exposure to U.S. markets. In this regard, beyond annoyance at certain aspects of U.S. foreign policy, another critical factor will be whether markets perceive the successor to current Federal Reserve Chairman Jerome Powell to be a credible steward of the Fed’s institutional independence from a president who has made no secret of his desire for much lower interest rates.
Powell’s term ends on May 15, and markets are expecting that a replacement will be announced soon.
Beyond purely financial considerations, linking tariff threats to extravagant geopolitical demands could also lead countries outside the U.S. to cost/benefit analyses that pit acquiescence against the economic costs of resistance. And this may have been the calculus that motivated resistance in Europe to Trump’s demands.
While certain EU sectors — pharmaceutical, engineering and auto industries — do have significant exposure to the U.S., total EU exports to the U.S. amount to about 2.5% of GDP. This is not only a relatively small amount but also a fraction roughly in line with the increase in defense spending that Washington is demanding from Europe.
But such increased spending would also be an alternate source of demand that might make up for a reduction in exports to the U.S.. In other words, combining threats of tariffs AND a withdrawal of the U.S. security umbrella as mechanisms of geopolitical suasion might be counterproductive (from Washington’s point view). This is because the very quest for autonomous security in the face of a more reluctant (or unreliable) U.S. could offset the macroeconomic pressures that are believed to come from targeted tariffs.
Thus, the tools of economic coercion may not work at all times, particularly against large and powerful targets, whether it is because such coercion might blow back against the initiator or because coercion itself can lead to outcomes that eventually reduce such targets’ vulnerability. And the specter of such coercion can lead to its targets seeking to diversify both their economic and geopolitical relations, with middle powers in particular seeking greater strength in cooperation.
This was precisely the message of Canadian PM Mark Carney in his much-heralded speech at Davos. This might be a lesson that Washington ends up learning repeatedly over the next few years.
