Another Sleeper Has Awoken

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I wrote early last year about what I see as the need for the world to awaken from its slumber and realize that the post Cold War world is over. I also wrote that I see Europe at particular risk in this new world.

It is led by Germany as the most populous country with the largest economy. Unfortunately that leader has a pathological aversion to debt, no military to speak of, a declining population, and has been governed by de-growth fanatics who shut down all their nuclear power.

That’s not a great combination of characteristics in the new world we are entering. Worst of all it seemed Europe and, Germany most of all, was asleep to the implications.

But what a difference a month makes!

In the wake of Vance’s performance at the Munich Security Conference last month and after the White House meeting/disaster last week with the Ukrainian President, I think we are seeing an awakening. Germany went from slumbering like Smaug in the Great Hall of Thrain (Hobbit reference) to an actual live player with an ability to shape the future.

Germany’s Renaissance 

The signal that Germany is in a new era came after the elections in February. The right of center CDU/CSU Party led by Friedrich Merz won a plurality and is working on forming a coalition with the left of center SPD party that led the last government.

Initially I thought this was a bad sign. Grand coalition governments tend to give everyone a little bit of what they want and prevent rapid change. This has led to a cautious and plodding approach as the rate of change accelerates around Germany and Europe as a whole.

But in the wake of the Zelenskyy meeting, Germany did something unprecedented. The CDU and SPD agreed to undertake almost $1 trillion in spending on defense and infrastructure over the next 10 years. That’s more than Mario Draghi asked for in his report last year and people thought that was unlikely.

They also got the European Commission to endorse the approach to deficit spending. Germany is basically ripping up and throwing away all the rules it forced the EU to make to protect itself from the profligate Southerners like Italy and Greece.

What the…?

I am left speechless. Trump and his seeming abandonment of the US security guarantee for NATO seem to have remade Germany in 30 days.

The Effects

This is ground shaking. Many of the effects will be good for Europe. Germany’s fiscal stimulus will power European growth. Europe will become a new force to be reckoned with that the world and especially Russia will need to adapt to. I don’t know but maybe it even gets Germans to stop being so depressed and have babies again. Who knows?

On the other hand there will be negative and positive impacts for the US. Certainly shedding the burden and cost of protecting Europe is a plus. It’s also good to have capable allies that can help you achieve geopolitical goals. Europe had become increasingly irrelevant militarily.

But there are downsides. The debt Germany issues to fund these priorities and the growth that funding spurs will suck money out of the US. With DOGE running wild and a confused tariff policy dominating the US, I think European stock and bond markets become very attractive.

Second, this will impact reserve currency holdings. You couldn’t park much money in European assets when they didn’t issue much debt and their stocks were stuck in neutral. Germany just made both more attractive.

In the end balancing the burden of managing the reserve currency will be better for the US but it means a down draft in US asset values in the short to medium term.

Third, Europe will now conduct a more independent foreign and military policy. As I’ve pointed out before, Europe isn’t threatened by China in the same way the US is.

It doesn’t see Taiwan as their problem the way the US does. The Pacific is more distant.

I see them naturally trying to play the US and China off each other rather than allying with one or the other. Trump’s attitude toward NATO will speed that transition.

The New Rules mean many former sleepers will awaken. A big one just did. Stay tuned.

Keep learning,

Alan

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