Harry Geels: German ‘Schuldenwende’ has five major implications
This column was originally written in Dutch. This is an English translation.
By Harry Geels
The recent elections in Germany have led to a political landslide. The intended new chancellor, Friedrich Merz, has declared a kind of ‘whatever it takes’ to pull Germany, and in its wake Europe, out of the doldrums with extra money and investments. This has five important implications, or perhaps better said: complications.
The change in German economic policy under the intended chancellor Friedrich Merz marks a historic change in European economic policy. Merz has announced that Germany is prepared to take on substantial debts to stimulate the weakened economy and strengthen European defence capabilities. This drastic policy change, aptly referred to as a ‘debt restructuring’ by Der Spiegel, has far-reaching consequences for Europe's economic and geopolitical position.
Specifically, Merz wants to lift the German limit on government loans in order to invest €500 billion in infrastructure projects. This change of course stems from two urgent challenges: the declining competitiveness of the German economy and the need for Europe to become more militarily independent in light of changing American policy. Let's list five important implications of the new ‘wende’, and then look at how investors can act on it.
1) Systematically managed economy
It was already in the plan presented by Mario Draghi in September last year, but Merz is proposing something similar, with a focus on infrastructure, which can of course be interpreted broadly, namely: technological and physical (such as roads and bridges). The €500 billion that Merz mentions is quite close to the €800 billion that Draghi mentioned for Europe. Such investments also have a clear political impact. We are letting the government take the lead, not the free markets. Capitalism has long since ceased to exist.
2) More inflation risks
If the government starts spending more, that means inflation. What's more, in the current climate, where inflation is already higher than economic growth and (savings) interest rates, and there is a labour shortage, inflation is fuelled. As Nobel Prize winner Milton Friedman clearly explains in this YouTube video in three and a half minutes, inflation is primarily caused by monetary policy that accommodates expansive government spending. Ultimately, citizens pay the costs of this, either through taxes or through loss of purchasing power due to inflation.
3) More debt for future generations
Increasing the national debt shifts part of the financial burden to future generations. Of course, investments are not always a bad thing, as they can also result in economic growth, but we must be vigilant about what the investments will yield. A government does not conduct as strict cost-benefit analyses of investments as the business community does. If certain investments are necessary, we could also look at how investments by the business community can become profitable sooner with less restrictive regulations and bureaucracy.
4) Convergence within the eurozone
The fourth implication of the new investment plans is that they could potentially strengthen Europe. Germany will move towards the southern European countries in terms of budgetary discipline. This will reduce the tension between North and South in the eurozone. This has given the euro exchange rate a boost. Investors also seem to find this interesting, at least for the time being, judging by how European shares have been doing better than American shares in recent weeks. Judging by the rapidly rising interest rates on the capital markets, investors are less reassured.
5) Free passage to eurobonds
The door to eurobonds that are not in accordance with the treaties has been opened once again – after the earlier coronabonds – under the heading of ‘war bonds’. Merz has said that Germany will participate in their issuance, and is putting everything in the sign of ‘whatever it takes’ to set the spending and war machine in motion. The Netherlands, which has always been largely opposed to joint debt, also seems to be (forced) to go along, despite having always voted against it in previous motions in the Lower House. I have previously expressed concerns about Eurobonds.
Consequences for savers and investors
It is crucial for investors to understand the market implications of the policy change, regardless of personal views on its desirability. Savers will pay for these investments through inflation, one way or another. Investors may be able to profit by taking positions in sectors that will directly benefit from increased government spending, such as defence, infrastructure and industrial companies, with a renewed focus on European markets. Raw materials may also potentially benefit from reindustrialisation.
There are also consequences for international capital flows. If more savings in Europe are released for investments in the region, this means that less will be invested outside of Europe, including in American stocks and bonds, which is likely to put further downward pressure on the dollar and upward pressure on interest rates. Not only that of Europe, but also that of the US. Diversification between countries and regions in the world will probably have more diversifying effects than in recent decades.
This article contains the personal opinion of Harry Geels
