Investment Strategy:  Third Quarter 2021Germany – More Kraftwerk Required

The sighs of relief will have been long and genuine at the headquarters of the CDU (Christian Democratic Union), as early election results came through from the small east-German state of Saxony-Anhalt, which showed a comfortable lead for the party in its state election. As in other countries, the pollsters seemingly misfired yet again, predicting right up to election day itself the CDU was in a neck and neck dog fight with the far-right AFD (Alternative for Germany). Whilst this result may well make the path to political stability continue in September’s Federal election, there are plenty of challenging forces within Germany and Europe as it moves out of the Merkel-era and towards a new post-pandemic dawn.

The importance of friendship and unity in reconciling the fractured history of Europe and as a foundation to secure economic growth and expansion was not lost on Konrad Adenauer, Germany’s first post-war chancellor and grandfather of the European Union. In much the same way as the scars of wartime drove his desire for greater union within Europe into the foundations of the political institutions of Germany, similar scarring – this time from the effects of hyperinflation during the Weimar Republic – fostered the great fear of inflation that still haunts the corridors of the Bundesbank.

All for one and one for all?

The euro has been a boon for Germany’s current account balance, running a surplus as it has done since the early 2000’s and allowing German central bankers to swoon over their fiscal conservatism as Germany saved much more than it invested. Whilst good domestically, this has incubated grudges, particularly in those southern European states which were working under a currency too strong for their domestic economies and from many in Washington, who saw Germany taking advantage of its key trading partners with a grossly undervalued exchange rate. With southern Europeans receiving little capital investment from their northern cousins, but receiving plenty of doctrines about fiscal conservatism, frictions quickly emerged in the early stages of the pandemic when similar imbalances in medical supplies and equipment became apparent. 

Economic imbalances continued during the pandemic, as Germany lost far less ground than many of its European neighbours. The German economy shrank by approximately 5% in 2020, whereas economic output in countries such as France, Italy and Spain fell by nearly twice as much.  Similarly, unemployment in Germany is currently hovering around 4.5%, approximately half that of France and a third of Spain, which at 15.4% exposes Spain’s reliance on tourism and hospitality, and its incomplete recovery from the global financial crisis. In order to avoid a repeat of another lost decade of subpar economic growth, it is these inequalities that the ECB should focus on rather than setting policy based on the strength of the economy of its largest member and its most vocal grumblings from its central bankers. 

This is not to say that German policy makers have not become more pragmatic of late. Starting the pandemic so poorly stung European leaders into action and ultimately catalysed the agreement to create the €750 bn ‘Next Generation’ fund, which included debt mutualisation, which could only be achieved with significant movement in thinking from Berlin. Important milestones such as this pave the way for Europe to walk out of the pandemic on a stronger footing.

Eyes on the Horizon

If that shift in thinking has helped smooth the way for greater fiscal integration, then September’s election represents a new opportunity for German leadership to help set the vision and tone of the next stage of the European project. Whilst Angela Merkel has been highly skilled and proficient in maintaining a domestic coalition fixed in the centre ground, and at points serving as a global moral compass versus a rising strain of populist politicians, she has served more as a firefighter figure, rather than visionary such as Adenauer. In her sixteen years of leadership, ‘Mutti’ has been calmly proficient in putting out the fires resulting from various eurozone financial crises, the refugee crisis, Russian seizing of Crimea and the tortuous exit of the UK from the EU. 

If increasing fiscal integration helps undermine some of the questions that have plagued the euro since its inception, then the recent EU budget and country submissions on how they plan to spend the cash set to flow from the Next Generation fund is forcing leaders to focus on the landscape ahead rather than concentrate on what lies in their rear view mirrors. This comes after a period of geopolitical drift, in which a rising China and a recalcitrant Russia made headways amidst a damaging Trump era for post-war institutions such as NATO. A strong Germany within a more united and relevant Europe is showing early signs of global leadership both politically and corporately across such matters as the greening of the economy. 

The deal making and coalition building that takes place in the immediate aftermath of September has the capacity to shape Germany and Europe as it steps out of the pandemic. With the CDU receiving a recent boost in Saxony-Anhalt, largely at the expense of the Green Party, and the FDP making polling headway and SPD support flatlining, there remain plenty of coalition options and time for potential kingmakers to come to the fore. The most likely outcome would see a CDU/CSU & Green coalition assuming a meeting of minds between CDU’s desire to reduce tax and enact pension reforms and the Green’s tax realising agenda can be bridged.

Looking for Freedom?

The vaccine distribution programme in Germany is continuing to make excellent progress after its slow start. With the Bundesbank predicting a more optimistic economic recovery in 2021 and an even stronger 2022, coupled with inflation predicted to remain under control, the conditions are open for the ECB to entrench a bloc-wide recovery in a manner it failed to achieve during the last decade. Whether the leaders of Europe, with Germany at its heart, grasp the opportunity is yet to be seen. The challenge that awaits a new leader is to provide a clear pathway to drive Germany forward into a digitally-savvy green economy and to lead Europe away from what The Economist recently described as “The land that ambition forgot”.

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