Actually, I think I found a discrepancy with your game. I’m pretty sure that ownership of Gibraltar does not halt any movement through the Strait. That was just the first thing I noticed. Uhhh, maybe you should take your fighter and bomber sitting in London, and attack his sub. That, as you pointed out, will open up the possibility of the US taking Algeria. Then, whatever German forces occupy Lybia will have a threat on both sides. I might suggest moving your Inf. in Trans-Jordan into Anglo-Egypt to help out. That, however, depends on how many units (including air) are within range of Anglo-Egypt. If all your forces there, including the Inf. from TJ, will definitely get crushed, then yeah, I would have to agree with CC that a strategic withdrawal would be the way to go.
And yes, of course, take W.Europe, if only for the temporary increase in funds.