The European push to support Ukraine has stepped up a significant notch this week with Germany now announcing a huge raft of spending measures, with a large part unsurprisingly focused on defence.
Friedrich Merz’s “whatever it takes” plan to unleash defence spending and overhaul German infrastructure is set to usher in the largest economic stimulus since the fall of the Berlin Wall. While details still need to be fleshed out, the historic deal between the chancellor-in-waiting and his likely coalition partners, the centre-left Social Democrats, allows for potentially unlimited borrowing for defence spending and creates a €500bn 10-year fund to drive infrastructure investments. Economists expect the plan, which must still be approved by a two-thirds supermajority in parliament, can provide up to €1tn of additional borrowing over the next decade — a sum that represents more than a fifth of Germany’s entire economic output — and resurrect Europe’s largest economy after years of stagnation.
Is Rachel Reeves watching?
To be fair, German Debt to GDP is somewhat below ours in the UK, as economists at Hamburg Commercial Bank are anticipating a rise in the debt-to-GDP level from 63 to 84%. In the UK it is around 100% already!
In the five years after reunification in October 1990, German debt levels shot up from 41 to 60% of GDP as the country increased public investment into the former German Democratic Republic’s rundown infrastructure. Since then, successive governments have adopted a model of fiscal restraint that resulted in years of under-investment in public infrastructure.
Goldman Sachs anticipates that the plan will drive German defence spending to as much as 3.5% of GDP by 2027 — up from 2.1% in 2024 and a mere 1.5% in earlier years.
Merz’s decision to leave behind Angela Merkel’s fiscal restraint comes amid a rapid unravelling of security ties between the US and Europe. With President Donald Trump threatening to end US security guarantees and, at least temporarily, cutting off support for Ukraine, Merz said Germany had to do away with guardrails to defend Europe against “threats to freedom and peace.”
Europe has turned on the stimulus, whereas the US appears to be going backwards for the time being. When Donald Trump rang the opening bell at the New York Stock Exchange on December 12, the chants of “USA” from the trading floor epitomised the investor exuberance that had greeted the president-elect’s victory and powered US stocks to a series of record highs. But just a few months later, the popular view was that the new president’s Make America Great Again agenda (MAGA) would boost US equities and the dollar, while hitting the currencies and stocks of its trading partners, well, not quite.
Markets are now concerned that Trumps much-vaunted policy of trade tariffs will hurt domestic growth. Tesla, whilst almost doubling in value after the US election to the middle of December, has now fallen back to pre-election valuations. Meanwhile, the US’s foreign policy, dare I mention the horrendous TV debacle with Zelensky last Friday, has galvanised Europe’s politicians into promising a defence spending boom that has lifted the region’s assets. In Europe, defence stocks have soared. Germany’s Rheinmetall is up 130% over the past six months, and infrastructure stocks have also been big winners in anticipation of greater government spending, with Siemens Energy up by almost the same amount.
I have been doing this for a long time, but I struggle to remember a time when the fortunes of the US and Europe have switched over so rapidly and with such a great effect. Maybe the MAGA trade has become a MEGA trade – Trump, by accident, may just have Made Europe Great Again. Do have a good weekend.
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