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German military spending has 
been in the news a lot in recent

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days, which isn't always a good 
thing. 

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The political parties that are 
expected to form Germany's next 

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government agreed this week to 
overhaul borrowing rules, 

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creating a €500 billion 
infrastructure fund, exempt 

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defence spending above 1% of GDP
from Germany's strict 

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constitutional borrowing limit 
and loosened debt rules for 

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states. 
This is a massive shift in 

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spending to revamp the German 
military and revive growth in 

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Europe's largest economy. 
America's turn away from its 

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traditional allies towards 
Russia and its move away from 

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free trade may be the biggest 
shift in global trade relations 

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since the collapse of the 
Bretton Woods agreement, 

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according to Reuters, and may 
have sparked the most dramatic 

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shift in German fiscal policy 
since its reunification. 

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Friedrich Mertz, whose 
conservatives won Germany's 

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election last month, is planning
to push these spending changes 

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through parliament before new 
lawmakers take their seats in a 

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few weeks. 
This is a bit unusual as Mertz 

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won't become chancellor until 
then, But the German debt break 

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is a constitutional provision or
part of the Basic Law, and 

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amending it requires a 2/3 
majority vote. 

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The far right Alternative for 
Germany, which was promoted by 

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both Elon Musk and JD Vance in 
the lead up to the election, and

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the radical left wing populist 
party both have close ties with 

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Russia and oppose any additional
military spending. 

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These fringe parties won 
sufficient seats in the recent 

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election that when combined they
have enough votes to block any 

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constitutional changes in the 
next legislative period. 

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For that reason Mertz has to 
move quickly. 

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Afd opposes any change in the 
rules and the radical left party

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opposes any additional defence 
spending, meaning that if this 

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spending is to be approved, it 
must be approved right away. 

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The yield on the 10 year German 
Bund made headlines when it rose

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to 2.8% on Wednesday in its 
biggest one day move since the 

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fall of the Berlin Wall and the 
DAX. 

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The German stock index rose 3.4%
as markets priced in more 

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economic growth, boosting risky 
assets like stocks at the 

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expense of government debt. 
The euro strengthened against 

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the dollar and European defense 
stocks rose, while US defense 

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stocks and the overall U.S. 
market fell. 

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We saw strength in European 
infrastructure stocks and 

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European financial stocks too. 
So far this year, the euro 

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stocks index is up over 11%, 
while the S&P 500 is down almost

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2%. 
This was not what many expected 

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when Trump won the election. 
Germany has been in recession 

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for the last two years with no 
economic growth over the last 

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five years, marking one of the 
longest periods of economic 

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stagnation in its post war 
history. 

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Many economists were warning of 
a potential third year of 

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recession in 2025. the FT 
described this planned increase 

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in spending as a double bazooka 
for defence and infrastructure. 

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The announcement is being 
compared to Mario Draghi's 

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Whatever It Takes speech, which 
marked the turn around of the 

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euro crisis in 2012. 
And Deutsche Bank. 

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Economists described Mertz's 
deal with the rival Social 

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Democrats as one of the most 
historic paradigm shifts in 

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German post war history, saying 
that both the speed at which 

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it's happening and the magnitude
of the prospective fiscal 

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expansion is reminiscent of 
German reunification. 

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So this is quite a big deal. 
The German debt break was first 

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introduced under Angela Merkel 
in 2009 in the wake of the 

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global financial crisis, when a 
bank bailout led to a sharp 

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increase in government 
borrowing, which had already 

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been rising for years. 
The rule limited new borrowing 

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to .35% of GDP, which was a 
tight limit compared to EU 

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budget rules requiring less than
3%. 

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There was a lot of debate around
the introduction of the debt 

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break, with critics arguing that
the state was restricting its 

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own ability to act. 
Proponents, on the other hand, 

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said that if debt was allowed to
grow, the state would have to 

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spend more and more on interest 
payments, burdening future 

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generations. 
Public investment in 

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infrastructure in Germany has 
long been a problem. 

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It first declined in the 1990s 
and then was kept so low that it

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hasn't even covered the 
depreciation in the existing 

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infrastructure. 
Having high quality public 

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infrastructure means that you 
have to be spending enough money

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to maintain it, which Germany 
has not been doing. 

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Germany has been near the bottom
of advanced economies in public 

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investment for decades, and even
when money was budgeted for 

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investment, it was frequently 
still underspend. 

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Many of Germany's roads and 
bridges are crumbling today. 

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As many as 5000 of the bridges 
along the nation's world famous 

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autobahns are in such poor 
condition that they've been 

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flagged as being in urgent need 
of repair. 

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In September, the Corolla Bridge
in Dresden, which was scheduled 

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for renovation, collapsed 
overnight into the Elba River, 

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causing severe disruption to 
both road and ship traffic. 

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Most German economists today say
that the debt break is too 

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strict, and even Angela Merkel, 
who introduced it in 2009, has 

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come out to say that it should 
be lifted, but only to allow 

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investment. 
Disagreement over the debt break

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and the need for additional 
military spending is what led to

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the collapse of the German 
coalition government and the 

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snap election that occurred last
month. 

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Germany's decision to give up on
fiscal restraint is driven by 

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the rapid unwinding of security 
ties between the United States 

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and Europe, with the US 
president threatening to end US 

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security guarantees and cutting 
off support for Ukraine. 

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Mertz said that Germany had to 
do away with guardrails to 

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defend Europe against threats to
freedom and peace. 

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While German interest rates rose
the most in 17 years on 

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Wednesday, analysts were not 
concerned with any deterioration

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in German credit quality. 
S&P Global said that the ramp up

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in defence and infrastructure 
spending would in fact be a 

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positive for Germany's prized 
AAA sovereign credit rating. 

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They said that their biggest 
concern had been the stagnating 

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economy and that anything that 
would boost the domestic economy

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was a credit positive. 
Germany's low debt levels mean 

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that it's under leveraged when 
compared to big economies around

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the world, and it has plenty of 
room for additional spending. 

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According to UBS, if this 
package passes, government 

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spending could increase by a 
cumulative 20% of GDP over the 

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coming decade, which would be 
the biggest fiscal shift in 80 

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years, surpassing the spending 
that occurred during the 

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reunification of Germany in the 
1990s. 

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They go on to say that even if 
Germany were to increase 

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spending to that level over the 
next 10 years, assuming a 

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moderate growth multiplier, 
their simulations indicate that 

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Germany's debt to GDP ratio 
would still land in the mid 60% 

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area by 20-30, which compares 
favourably to ratios of 115% in 

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France and 124% in the United 
States. 

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Importantly, the planned 
infrastructure spending is badly

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needed and can be expected to 
grow the German economy. 

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When a country needs investment 
and gets it, it's positive for 

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growth and very different to 
when a country doesn't need new 

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infrastructure but builds it 
anyhow, which is malinvestment. 

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And with malinvestment, the cost
of debt is greater than the 

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return on investment of the 
underlying project. 

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For many years, Germany has been
a critic of any effort to make 

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it easier for European 
governments to spend money over 

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fears that it could saddle the 
eurozone with debt and risk the 

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stability of the euro. 
The German approach up until 

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this week was to completely 
ignore growth and try to lead by

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example with extreme spending 
restrained. 

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The US President's repeated 
threats of tariffs on EU 

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imports, along with the US Vice 
President's scolding of European

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leaders last month at the Munich
Security Conference, followed by

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the disastrous meeting with 
Ukrainian President Zelensky 

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which ended in a public shouting
match, spurred on this massive 

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U-turn in German and overall 
European politics. 

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Analysts who had been projecting
flat economic growth for Germany

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are now projecting growth of 1.8
to 2%, which is roughly in line 

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with German growth before the 
pandemic. 

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The European realization that 
the United States can no longer 

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be counted on as an ally is 
likely to cause big changes 

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throughout Europe. 
Yesterday, the former French 

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President Francois Hollande 
wrote in The Economist that 

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while the American people may 
still be our friends, the Trump 

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administration is no longer our 
ally, he writes. 

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This is grave. 
It marks a fundamental break 

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with the historic relationship 
between Europe and America and 

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the link established published 
after the Second World War with 

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the creation of the Atlantic 
Alliance. 

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He voices concern that diplomacy
and reason may fall upon deaf 

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ears and concludes that European
nations must step up military 

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spending and more importantly, 
cooperation. 

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00:10:05,600 --> 00:10:08,880
He points out that France, 
Britain and Germany, when 

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combined, already spend more on 
defence than Russia does, but 

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the greater cooperation is 
needed between European 

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countries that oppose Russian 
aggression. 

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The talks to increase spending 
in Germany came as the European 

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Commission outlined on Tuesday a
joint debt instrument that would

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enable member states to fund the
purchase of military equipment. 

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The debt instrument would 
involve the European Commission 

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borrowing against the EU budget,
then lending to member states at

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low interest rates. 
This would require unanimous 

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backing from EU countries, which
may be difficult to achieve. 

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The €150 billion in loans could 
buy air and missile defence, 

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artillery systems, missiles, 
armed drones and anti drone 

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systems, but also be used to 
address other means from cyber 

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to military mobility, according 
to the president of the 

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Commission, Ursula von der 
Leyden. 

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She added that lifting EU fiscal
rules for defence investments 

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would enable countries to spend 
€650 billion on defence over 

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four years, or about one and a 
half percent of GDP on average. 

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00:11:20,400 --> 00:11:23,680
While US defense stocks have 
declined since Trump took 

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office, European defense stocks 
are up more than 30% on average 

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as investors have concluded that
Europe will be spending a lot 

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00:11:32,360 --> 00:11:35,520
more on defense, but that 
they'll likely be spending it 

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internally if possible. 
While traditionally a lot of 

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European defense spending would 
have been on American weaponry, 

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investors now expect to see them
spending more domestically, as 

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when foreign governments buy 
weapons from the United States, 

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the United States does get a say
in how these weapons are used. 

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With the US aligned more closely
with Russia, European buyers are

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now considering the risk of 
being unable to use American 

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00:12:02,600 --> 00:12:04,920
weapons in a conflict with 
Russia. 

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00:12:05,320 --> 00:12:08,520
Canadian newspapers have 
similarly raised alarm about 

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00:12:08,520 --> 00:12:13,160
buying fighter jets from their 
newly hostile neighbor. the FT 

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00:12:13,160 --> 00:12:17,320
reported yesterday that Europe 
is rushing to provide Ukraine 

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with alternatives to Starlink, 
Elon Musk's satellite Internet 

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provider, after the US withdrew 
military aid and intelligence 

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00:12:25,440 --> 00:12:28,160
sharing. 
This week, four large European 

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00:12:28,160 --> 00:12:31,640
satellite operators confirmed 
that they're in talks with 

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00:12:31,640 --> 00:12:34,880
European governments and 
institutions about providing an 

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alternative. 
Provincial leaders in Canada 

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00:12:38,360 --> 00:12:41,440
reported that they are 
cancelling or no longer seeking 

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to deal with Starlink. 
And Mexican telecom billionaire 

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00:12:44,800 --> 00:12:49,000
Carlos Slim cancelled a deal 
with Starlink, opting to invest 

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00:12:49,000 --> 00:12:51,680
in his own telecom 
infrastructure rather than 

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00:12:51,680 --> 00:12:55,600
relying on Musk's satellite 
technology after being insulted 

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00:12:55,600 --> 00:13:00,240
on Twitter by Elon Musk. 
Musk famously blocked Ukrainian 

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00:13:00,240 --> 00:13:04,240
access to Starlink in Russian 
occupied territories of Ukraine 

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00:13:04,240 --> 00:13:09,040
in 2022 to prevent a Ukrainian 
military initiative, making 

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00:13:09,040 --> 00:13:12,800
Europe nervous about relying on 
it for military purposes. 

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00:13:13,440 --> 00:13:18,280
Sander Tordor of the Center for 
European Reform points out in a 

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00:13:18,280 --> 00:13:22,040
recent Foreign Policy article 
that Europe outproduces the 

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United States in steel vehicles,
ships and civil aircraft, 

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00:13:26,480 --> 00:13:30,040
meaning that the EU does have 
the industrial heft and 

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00:13:30,040 --> 00:13:34,240
financial firepower to support 
Ukraine and rearm their own 

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00:13:34,240 --> 00:13:37,720
militaries, with little reliance
on the United States if 

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00:13:37,720 --> 00:13:41,120
necessary. 
But it will need to invest in 

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00:13:41,120 --> 00:13:44,280
its defence and protect its 
manufacturing manufacturing base

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00:13:44,400 --> 00:13:47,920
against China's trade dumping 
and US tariffs. 

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00:13:48,240 --> 00:13:52,920
On average, he says, 
manufacturing accounts for 16.4%

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00:13:52,920 --> 00:13:57,400
of the EU's gross value added, 
compared to just 11% in the 

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00:13:57,400 --> 00:14:00,280
United States. 
And the EU's manufacturing 

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00:14:00,280 --> 00:14:05,400
sector employs 30 million people
versus just 13 million people in

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00:14:05,400 --> 00:14:08,640
the United States. 
He argues that Germany's 

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00:14:08,640 --> 00:14:12,400
existing industrial supply 
chains double up as defence 

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00:14:12,400 --> 00:14:17,320
supply chains if necessary. 
Sander points out that the 

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00:14:17,320 --> 00:14:21,400
European defence industry is 
weakened by fragmented bespoke 

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00:14:21,400 --> 00:14:24,640
production and years of 
underspending on defence. 

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00:14:24,840 --> 00:14:28,160
He argues that the EU needs to 
move towards standardized 

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00:14:28,160 --> 00:14:31,520
military equipment that can be 
mass produced and that 

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00:14:31,520 --> 00:14:35,360
governments need to give the 
European defence industry stable

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00:14:35,360 --> 00:14:38,840
long term contracts so that but 
they can scale up production. 

230
00:14:39,360 --> 00:14:43,120
Other weaknesses he highlights 
are that European manufacturers 

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00:14:43,280 --> 00:14:46,800
rely heavily on China for many 
critical components like 

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00:14:46,800 --> 00:14:50,600
batteries and critical minerals.
China was able to cut off the 

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supply batteries to AUS drone 
maker last year, making it 

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difficult to deliver military 
drones to Ukraine. 

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European arms manufacturers 
could obviously face similar 

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problems in the future. 
We're in very early days and 

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it's very difficult to predict 
how these relationships will 

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hold in the coming years. 
In order to reach a point where 

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Europe really pivots, you need 
the nations to decide that 

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something needs to be done and 
then you need the politics to 

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align. 
Europe has a small defence 

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sector at present which will 
need to be invested in and built

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up, and this could possibly 
serve as a growth engine for the

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entire continent. 
While spending on necessary 

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infrastructure is more likely to
drive growth, there can be 

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spillovers from defense spending
too, where new technologies are 

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developed that have civilian and
commercial uses. 

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Military spending in the past 
led to the airline industry, the

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Internet and nuclear energy. 
The fact that Germany has 

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decided to lead the charge is a 
big deal. 

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As Germany makes up about 1/3 of
the European economy. 

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It has engineering expertise and
excess capacity. 

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Analysts are projecting that 
Germany could potentially target

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3 to 3 1/2 percent of GDP for 
defence spending. 

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This would still be below what 
Germany spent during the Cold 

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War, when defence spending went 
as high as 4.9% of GDP. 

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Raising defense spending to 3% 
would more than double Germany's

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annual defense budget, and Ernst
and Young estimate that this 

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would create over 245,000 direct
and indirect jobs in the 

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country. 
German revitalization is good 

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for European growth, as in 
recent years Germany has been 

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the main drag on growth. 
It's possible that a new focus 

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on defense in Europe could also 
help the continent catch up in 

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technology, a sector where it's 
been a laggard when compared to 

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the United States and China. 
Automakers, which have been 

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Germany's economic powerhouse 
for decades, are today cutting 

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jobs and closing factories. 
Using this excess capacity for 

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military production would help 
preserve Germany's manufacturing

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infrastructure while boosting 
the output of military 

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00:17:10,200 --> 00:17:13,599
equipment. 
ZF Group and auto parts 

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00:17:13,599 --> 00:17:16,880
manufacturer, which is going 
through a restructuring that 

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00:17:16,880 --> 00:17:20,560
could lead to factory closures, 
told Reuters that they've been 

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in touch with defense companies 
about shifting workers, citing 

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00:17:24,960 --> 00:17:29,160
industrial synergies. 
Rhine Metal, a German automotive

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00:17:29,160 --> 00:17:32,880
and arms manufacturer, is in 
talks with Continental about 

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00:17:32,880 --> 00:17:37,040
taking on around 100 employees 
to beef up operations. 

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A lot of the struggles that 
Europe has had in the past have 

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been around integration and 
political discord. 

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00:17:43,920 --> 00:17:47,040
It's possible that Trump's 
behaviour in recent weeks has 

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00:17:47,040 --> 00:17:50,760
spurred action that could bring 
an end to internal squabbling 

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00:17:50,920 --> 00:17:53,720
and bring about a greater 
European integration. 

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A lot will depend on what the US
does in the coming years, but 

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with the constant threats of 
tariffs splintering supply 

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00:18:01,320 --> 00:18:05,120
chains and the rest of the world
viewing the US as an unreliable 

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signatory on trade deals and 
alliances, Europe may need to 

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00:18:09,120 --> 00:18:12,240
plan for a world where they no 
longer count on the United 

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00:18:12,240 --> 00:18:15,160
States. 
When the Cold War ended, we were

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left with a unipolar world where
the US was the only remaining 

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superpower. 
While China grew in influence 

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00:18:21,880 --> 00:18:26,040
over the last 20 to 30 years, 
Europe never became a truly 

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00:18:26,040 --> 00:18:30,280
independent third pole due to 
its reliance on other nations 

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00:18:30,280 --> 00:18:32,360
for its energy and defence 
needs. 

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00:18:32,600 --> 00:18:36,600
It's slow economic growth driven
by chronic underinvestment kept 

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00:18:36,600 --> 00:18:40,400
Europe in a state of political 
and economic weakness, which 

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00:18:40,400 --> 00:18:43,360
Trump and Vans now seek to 
capitalize on. 

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00:18:43,880 --> 00:18:47,280
The European recognition that 
the United States is less of an 

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00:18:47,280 --> 00:18:51,120
ally than was previously 
believed may bring an end to the

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00:18:51,120 --> 00:18:54,920
political gridlock that has held
the continent back for years. 

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00:18:55,200 --> 00:18:58,440
It's difficult to predict how 
Trump's plans will affect the 

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00:18:58,440 --> 00:19:01,920
United States or its trade 
partners as they seem to 

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00:19:01,920 --> 00:19:05,960
constantly change, but it is 
possible that the potential 

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00:19:05,960 --> 00:19:10,320
crisis facing Europe has forced 
its leaders to come together as 

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00:19:10,320 --> 00:19:13,720
they race to reinvigorate their 
economies and catch up. 

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00:19:14,080 --> 00:19:16,200
Thanks for tuning into this 
week's podcast. 

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00:19:16,360 --> 00:19:19,320
If you found it interesting, 
please tell a friend or send 

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00:19:19,320 --> 00:19:22,120
them a link as there's no 
podcast algorithm. 

307
00:19:22,360 --> 00:19:26,000
They just grow by word of mouth.
Have a great week and talk to 

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00:19:26,000 --> 00:19:27,560
you again soon. 
Bye.