Investors’ sudden loss of confidence in “American exceptionalism” – the notion that US assets should be valued more highly because of the US dollar’s role as the world’s pre-eminent reserve currency, the resilient US consumer market and the dominance of US technology companies in global equity indices – has amplified the impact of a potentially far-reaching shift in the political and economic governance of Europe.
Friedrich Merz, Germany’s chancellor-in-waiting, announced on March 4 a plan to reform the country’s debt brake, a constitutional provision that lets the government run only small fiscal deficits. This move to fund massive investments in defence and infrastructure was described by Merz himself as a “whatever it takes” moment for Germany and Europe.
Investors appear to believe the biggest fiscal stimulus since German reunification is comparable to the famous intervention by former European Central Bank (ECB) governor Mario Draghi in 2012 to pledge unlimited support to keep the euro zone intact, which put an end to the acute phase of the euro zone debt crisis. On March 5, the yield on Germany’s 10-year bond experienced its sharpest daily rise since March 1990.
That Germany is taking a “big bazooka” approach to the economy and defence is beyond dispute. Merz’s plan would unleash €500 billion (US$545 billion) in infrastructure investment over a 10-year period. It would also allow unlimited borrowing for defence spending. JPMorgan described the plan as “a massive U-turn on fiscal policy” that was decided “in the Oval Office”.
The revival of US isolationism has also served as a catalyst for the EU to boost defence spending. The European Commission has proposed temporarily easing the bloc’s fiscal rules to allow member states to significantly increase their military expenditure, as well as €150 billion of new joint EU borrowing to help rearm the continent.
