The euro rose to its strongest level in nearly four months today, while Germany’s borrowing costs experienced their biggest one-day surge since 1997, after Europe’s largest economy proposed a historic debt overhaul in a bid to beef up its military and revive growth.
“In view of the threat to our freedom and to peace on our continent, the mantra for our defense has to be, ‘whatever it takes,’” said Friedrich Merz, leader of the center-right CDU party and the man almost certain to be Germany’s next chancellor, as he sought to justify a move that would allow open-ended borrowing for defence spending.
The parties hoping to form Germany’s next government on Tuesday – the CDU and centre-left SDP – have hatched a plan to reform the country’s constitutionally enshrined state borrowing limits – known as the “debt brake” – so that military spending is exempt from it.
The reform marks a rollback of borrowing rules imposed after the 2008 global financial crisis.
They have also agreed to spend more than $500 billion over the next decade to help modernise domestic infrastructure. A commission of experts will separately develop a proposal for modernising the debt brake to boost investments on a permanent basis.
The plan could still fall through. The prospective coalition partners will need to put their proposals to the German parliament next week.
But the fiscal sea change is a stark reminder of the seismic shift underway in Europe. Ever since the fall of the Berlin Wall, Germans could be expected to keep budget deficits relatively low, military spending even lower.
“Pending more clarity on this issue, and being mindful of some execution risk, we believe this is one of the most historic paradigm shifts in German postwar history,” said Robin Winkler, chief economist at Deutsche Bank Research.
It is worth remembering why Germany’s most recent three-party coalition collapsed, sparking early elections. Olaf Scholz’s SDP party and the Greens wanted to suspend Germany’s constitutionally enshrined spending limit and take on more debt in order to bolster a Ukraine support package by €3 billion and to initiate a programme to save jobs in the car industry. Christian Lindner, a fiscal hawk, from the liberal Free Democrats, refused to get on board, opposing any new borrowing and instead calling for lower taxes and cuts in social spending.
The decision to take on more borrowing won’t have been an easy one for Merz to make. After all, it’s a break from his more fiscally conservative campaign promises.
But a lot has changed even since he was out on the campaign trail. And America’s dramatic retreat as a guarantor of European security has left Germans feeling perhaps even more vulnerable than other major European powers, France and UK. Unlike them, it is not a nuclear power.
Merz clearly wants to show that he is serious about the existential threat facing Europe, and that he’s prepared to take drastic action to counter it.
More borrowing is a risk. But he’ll be hoping that the spending helps revitalise Europe’s economic engine, which has contracted for two consecutive years. And he will take some comfort in the fact that defence is a growth industry.
Caitlin Allen
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