German revival?

“War made the state, and the state made war” (Charles Tilly)

Some have argued for war as definitive in Europe’s ultimate triumph over millennia of stagnation. For much of the Middle Ages, Europe was a savage backwater relative to more peaceable (and technologically sophisticated) empires such as Abbasid caliphate and Song. However, it was from this same chaotic patchwork of constantly warring states that the institutions and culture complementary to modern economic growth unevenly emerged.

The argument goes something like so – waging constant war required vast amounts of financing. Building such fiscal capacity forced many of these uppity princelings into the arms of commerce, sometimes at the expense of religious legitimation. Out of this Darwinian selection process, with hundreds of states whittling down to under fifty in a matter of centuries, highly competitive states with the requisite fiscal capacity emerged.

To today

The next few weeks are as important as any in Europe’s long history, with war and how to finance it again in the middle of everything.

The euro project’s unfinished fiscal and political architecture has once more been laid bare by the needs of the moment. If defence, migration and fiscal space are at the core of what it means to be a nation state, then Europe still more closely resembles a collection of nationally oriented democracies, wrestling with problems better solved at the regional level.

This obviously requires yet more precious sovereignty to be prized out of tightly clenched national hands. Unfortunately, the benefits offered in exchange are often disparate and insubstantial at the individual level – from lower borrowing costs to more cost-effective military procurement.

This hard-to-sell exchange can be helped along by external threats, whether from a more adversarial and transactional US administration, or indeed Russian aggression. That has certainly been the case this last decade or more.

German elections

This is the setting for a vastly consequential German election. The ill-starred ‘traffic light’ coalition came to office in January 2022 with Olaf Scholz, the continuity candidate from Chancellor Merkel, at their head. The ideologically unwieldy group were immediately bludgeoned by ‘events’. A month after they took office, Russia invaded Ukraine, a tragic and shocking rupture that was accompanied by soaring European natural gas prices.

The German economy was already being punished for its heavy reliance on an increasingly wobbly Chinese economy. Her dependence on Russian gas was then similarly flipped from asset to giant liability, ageing Chancellor Merkel’s legacy decades in a matter of days.

Germans will head to the polls this Sunday with the economy perhaps showing tentative signs of life, but still labouring. Even if peace between Russia and Ukraine could be durably found in the weeks ahead, the return of Russian gas is surely much further off. Meanwhile, Chinese policymakers still have it all to do in their battle with their property bubble aftermath.

Investors should obviously be cautious of assuming dramatic changes. The borrowing restraints are constitutionally guarded, requiring parliamentary supermajorities for change. Meanwhile, the popular stereotype of the thrifty Swabian housewife has more substance than realised by those imagining a total reworking of the German economy.

Such optimists likely also underestimate the complex patchwork of checks and balances that very deliberately limit executive power. Those same restraints should also provide reassurance to those worrying of the threat posed by the far right.

European stocks?

Europe’s stocks have had a barnstorming start to 2025. There are multiple potential reasons for this, but the key question is obviously, can it continue?

There are a variety of potential explanations for Europe’s lost decade (plus). Mario Draghi’s detailed report¹ suggests much of that is fixable. The market mechanisms by which companies are ‘selected’ or discarded are inferior to those in the US, as the IMF pithily argued² – “It is less likely in Europe that the ‘right’ firms survive and thrive, and that the ‘wrong’ firms exit.” The result is abundant small but mature low growth firms.

The capital markets union is surely one of the less contentious areas to move forward on in this context. Deep and liquid funding markets are part of what makes America great (anyway). A more efficient mechanism for capital allocation can surely help Europe too. Perhaps the progressing debate on defence funding can provide a bridgehead to work with.

Europe’s equities represent a still inexpensive option that the next decade is a bit different to the last. Perhaps out of all the tragedy and acrimony, something useful could emerge. A more coherent union able to deliver on a little of its still considerable promise. We can have cause to hope, but not expect.