Blain’s Morning Porridge Sept 24^th 2024: European Defence is now a priority – it opens up massive investment opportunities.

 Si vis pacem, para bellum

Europe is waking up to the reality of conflict, acutely aware of the need to defend itself, to invest and produce weapon systems to deter aggression in what is a vastly changed geopolitical landscape. With the right approach it may even become a driver of growth across the European economy.

The most effective British plane of the Second World War was the beautiful Mosquito, the “Wooden Wonder” as it was known. Built of cheap plywood and glue (because metal was needed for “proper” aircraft) in small furniture and piano factories around the UK, the two-man bomber flew higher, further, and faster, delivering a bomb load larger than a B-17, in daylight precision raids across Europe. The pilots took great delight in raids on Berlin timed to interrupt Nazi radio broadcasts. It suffered the lowest loss rate in the RAF, flying high above the anti-aircraft guns, low underneath radar (which bounced off the wooden structure, making it an early Stealth Bomber), while outrunning Luftwaffe fighters.

What most folk don’t know is the De Havilland aircraft company designed and built it as a private venture after the RAF laughed off the idea of wooden two-engine fighter bomber. There might be an investment lesson in the story of the Mosquito.

Over the past weekend, Europe commemorated the Battle of Arnhem. 700 European and US paratroopers fell from the skies onto the same heath where the UK 1^st Airborne Division dropped 80 years ago. It was poignant to see British Red Devils jump alongside German Fallschrimjager, whom they fought against in the battle. There was a message in that. We might not have played very nicely together during the first half of the 20^th Century, but things have changed in Europe – Europe is waking up. And about time to.

Over the past months there has been a massive and sustained sea-change in the urgency of discussions around European defence, and how to implement effective change. You can hear it being talked about in the corridors of power – including in the UK – and across global investment strategy desks. The implications are enormous, and perhaps more pressing and immediate than climate change and energy transition.

The wake-up moment has been driven by a growing realisation of just how substantially the World has changed over the last decade, and how unprepared Europe would be without The Arsenal of Democracy, the USA, standing in front of it:

• The threat of a Donald Trump/Republican disengagement from Europe and NATO as the US pivots to face China (rather than trade with them),
• How geopolitical fault-lines and global alignments have shifted as the US is no longer perceived as an infallible global hegemon,
• How the festering regional conflicts in Eastern Europe and the Middle East driven by Russia and Iraq stem from the reality these are now satellites in China’s orbit.
• While China didn’t create the war in Ukraine, nor the 3000 years of historical tribal tension in the Middle East, they are each opportunities for the Middle Kingdom to further and advance its own ambitions, while
• It begs the question – what instability might North Korea, the third rogue state in China’s bag, create?

The threat of Europe being dragged into global conflict and just how unprepared it may be, dominates a growing realisation swift European rearmament is required, triggering urgent discussions on how that can be effectively achieved and how quickly.

Swift, decisive, coordinated action is seldom associated with Europe’s decision making process. The global investment community largely considers Europe a conceptual work in progress, a bureaucratic talking shop where the institutions of the EU, EC and ECB are hamstrung towards compromise and vague consensus. While Europe still struggles with the construct and consequences of the Euro, there is massive national pushback on further fiscal and political union – much of it in doubt as right-wing populists dominate unstable politics, and Putin apologists like Viktor Orban runs Hungary, (and potentially a similar leader in Austria.)

Change is afoot.

The EC has appointed its first Defence Commissioner… Andrius Kubliius, former Lithuanian Premier. He has a mandate to reform and direct defence spending while pulling Europe’s massive but uncoordinated defence industrial base into a unified block. These plans include a European Defence Industrial Strategy and an Industrial Programme. While Europe loves appointing more committees and bureaucrats as the core of any initiatives – the potential gains are enormous.

Kubilius has already focused on logistics – the need to increase war stocks of equipment and ammunition to enable to Europe to fight as the best way to kick start the rebuild of Europe’s arms production. Amateurs talk about tactics – professionals study logistics.

There is a general acknowledgement across Europe that a massive increase in defence spending and planning is now required to secure its future. Most European nations are moving to honour the 2% of GDP defence spending target.

Rearmament is now top of the EU’s strategy, as was made clear in Mario Draghi’s recent EC report on invigorating Europe’s somnambulant growth. His reference to defence spending was notable. One soundbite headline takeaway was about the American’s making and using 1 tank (I would argue 2 – the M1 Abrams and the M2 Bradley), while Europe is using 12 different models of AFV!

A large part of Draghi’s report focused on defence. A key issue he highlighted was: increasing security and reducing dependencies. He recognised the need for secure and diversified supply chains for everything from raw materials to high tech (meaning Taiwan chips). He called for massive investment in semiconductor capacity and “developing Europe’s defence capability”.

Draghi argued this can best done at the European level – and given the cost of military development and procurement, and the success of previous cooperation, like the Tornado, Typhoon and AlphaJet programmes run by European firms, would boost the EC’s push towards fiscal unity across Europe under the EU banner. Draghi made the following points about European defence – setting out a blueprint for change:

• Our key weakness is excessive fragmentation of the [defence] industrial base, compounded by lack of coordination among Member States, unnecessary duplication and lack of interoperability of equipment.
• In the defence sector, common planning comes before common expenditure. 
• EU countries are, collectively, the second largest military spenders in the world, but we do not help our defence and space industries to build up scale. Collaborative procurement accounted for less than a fifth of spending on defence equipment procurement in 2022. 
• Almost four-fifths of total procurement spending went to non-EU suppliers. 
• The report recommends increasing the aggregation of demand between Member States, as well as raising the share of joint defence procurement and common R&D spending. 
• In the defence sector, this consolidation of spending should be matched by selective integration and consolidation of EU industrial capacity, with the explicit aim of increasing scale, standardisation and interoperability. 
• However, at the same time, higher scale should not lead to lower competition. 
• Europe has many highly sophisticated SMEs in the defence sector that could make an exceptional contribution to our common defence.
• Member States that are part of NATO are committed to invest at least 2% of GDP on defence per year. 
• EU leaders have discussed and agreed on the urgent, immediate and medium-term defence needs for Europe.

And most revealingly he added:

• Defence procurement will be a critical project to be funded through common debt..

Perhaps it’s time to look closely at the key European defence contractors and stocks – something I’m putting together.

The funding of new urgent European defence initiatives in a more threatening world will be a challenge. It could be the single biggest impetus to European fiscal unification yet. It’s happening as Europe is set to struggle with massive infrastructure renewal investment and repair, increased demographic, social and welfare bills and the need to invest in new digital tech and industrial resilience. It will drive the EC’s ambition that Europe evolves towards a single European Sovereign Debt market, eventually superseding Bunds, OATs and other national programmes. (Effectively that happened during the pandemic as Europe began issuing bonds to finance member states.)

Since the invasion of Ukraine, Europe’s war-planners have had an unrivalled opportunity to watch and plan for how conflict has evolved. Everyone talks about the effectiveness of drone warfare, but the reality is improved anti-air defences have evolved as quickly – new turreted, highly transportable and mountable, rapid-fire units can clear the skies. Even the UK’s vintage Challenger Tanks have shown that the right mix of armour, armament and mobility has made them perform effectively compared to US and German tanks. (That surprised me – one retired UK armoured officer I know had told me “they will be the safest tanks on the battlefield – they will have broken down long before they get there…”)

Top of the list of things to finance is the improvement of Europe’s air-defences. While the Israeli’s have demonstrated the effectiveness of their Iron Dome missile defence, confidently swatting down massive missile salvos sent by Iran, the air defence of the UK comprises a handful of Typhoon and Lightening (F-35) interceptors and 4 Sky Sabre batteries that can each handle 24 targets at a time. While these are good and effective (a bit like US Patriots) we need more of them and upgrades to take down ballistic, glide and hypersonic missiles.

The possibilities of new weapons construction – instead of massive factories, hardened 3D printing-based, automated and integrated industrial sites able to switch between the mass production of multiple weapon systems from missiles, tanks, mobile units and electronics – could be enormous. I cited the Mosquito at the top of this article, perhaps not a lesson to be missed in innovating new weapons from the private sector.

The media and many politicians – especially in the US – have become susceptible to an illusion that European defence is a simple issue: that it can all be solved when Donald Trump does a deal with Putin to end the Ukraine War, creating an economic boom as Europe thrives on cheap Russian energy. As Zelensky made clear yesterday in Washington; Ukraine has not bled itself to rewards Russia with its territory. Appeasing Russia would utterly miss what the Ukraine war has become – part of the challenge between emerging China and the US.

Don’t condemn China out of hand, it is making use of any and all opportunities, just as any sensible nation does. The fact China is supporting three rogue states is uncomfortable, but look at the states and dictators the US historically supported.

The Russia shills and sadly, many Republicans, seem to believe Russia’s false history of its rights in Ukraine, or that it’s the West’s fault. The reality is Russia is a opportunistic to-be-played pawn in China’s hands. It’s very much in China’s interest that Russia continues to undermine the US/European alliance – just as Iran continues to distract in the Middle East from China’s plans in the South China seas and the home islands.

Who knows how this plays out – but rearmament today now means the chance of war tomorrow will be lessened.

Out of time, and back to the day job….

Bill Blain

Author of the Morning Porridge, founder of Wind Shift Capital

www.morningporridge.com

www.windshift.capital

billblain@morningporridge.com

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