The second debt crisis: what will military borrowing in the EU lead to?
Newly elected German Chancellor Friedrich Merz has managed to reach a preliminary agreement from the Green Party on a large-scale investment program that will include infrastructure spending of half a trillion euros. All this is planned to be financed by increasing the national debt. This is also why German bond yields have skyrocketed to multi-year highs simply because of promises of new borrowings that have not even begun to materialize yet. Other European countries have an even worse situation, as the German "debt party" will affect them in one way or another. Eventually, there may be a repeat of the European debt crisis of the early 2010s, only now it may affect the key countries of the eurozone, and not just the southern periphery. Details can be found in the Izvestia article.
Selling debts to the EU and Britain
Last week, the head of Global Strategy at Bank of America (BofA, the second largest U.S. bank by assets and market capitalization) Michael Hartnett made some rather harsh statements. According to him, the "recession of the US public sector" has begun after five years of fiscal expansion, as evidenced by weak employment growth in government and quasi-government organizations. In addition, he believes that the policy of duties in America can lead to a full-fledged recession of the entire economy.
But even more interesting were his recommendations regarding the Old World. Hartnett believes that investors should sell UK and EU bonds. He referred to the rapid growth in German and British bond yields, which reached 15- and 27-year highs, respectively, which is likely caused by increased defense spending in the regions.
He predicted that German bond yields could exceed U.S. Treasury yields by the end of the year, and pointed to a possible crisis in British government bonds due to budget and current account deficits. The BofA strategist also recommended selling Japanese bonds, noting that few expected Japanese bond yields to exceed Chinese yields.
Indeed, European debt markets have started to shake in the last few weeks. It all started from the moment when the Christian Democrats, who won the German elections, unveiled their ambitious plans to stimulate the economy. Merz and the company planned to remove the budget from the "debt brake" — a mechanism that prohibits new borrowing in excess of 0.35% of GDP per year — and borrow about 500 billion euros over 10 years, as well as begin a rearmament program.
Even the authors of the proposal themselves do not yet know how much should be spent in total. However, we are talking about such a large amount that the bond market just collapsed. So, on March 5, yields on German securities soared by 30 basis points (0.3 percentage points), which is the biggest jump since 1988, that is, even before the unification of Germany.
The brake is broken
It is worth noting that the "debt brake" was adopted for a reason, but was a consequence of the global financial crisis of 2008. A year later, German politicians simply forbade themselves to collect debts. The relevant amendments were made to the basic law, meaning that in order to remove the budget from the brakes, a constitutional majority (2/3 of the votes) is needed.
To implement its plan, the party that won the election took an extremely rare step on the verge of legitimacy. Given that the far-right and left-wing factions won more than a third of the seats in the new Bundestag, it was decided to convene the old parliament, which was dominated by a coalition of the SPD, the FDP and the Greens. With the help of these parties, the CDU/CSU, which was outside the government during the last Bundestag, hopes to collect the necessary share of votes.
Apparently, the negotiations with the Greens, who had questions about the plan, were successful. However, the market did not really doubt this, considering the party's discontent to be nothing more than a pose. Nevertheless, successful negotiations led to a new jump in profitability, which came close to 3%. The last time such indicators were observed was in 2011, on the eve of the European debt crisis.
In principle, Germany has a large enough margin of safety to increase borrowing. Its debt figures are very small by the standards of the world's largest economies and amount to less than 65% of GDP. Among the top 10 global leaders, only Russia has a lower ratio (about 16% of GDP). But there are several "buts" on the way to increasing debt.
The first of them is that you will have to borrow very significant amounts at once — probably more than € 100 billion a year, so that the effect of investments will have an effect as early as possible. And this will heat up the market even more. High yields will become a nuisance in the future for the next governments, which will have to repay their accumulated debts at high rates. We also do not forget the fact that a considerable part will be spent on defense, that is, it will not give any long-term return to the economy and is likely to accelerate inflation.
Ricochet to France
Nevertheless, it would still be uncritical for Germany. However, Germany does not exist in a vacuum, being part of the single European debt market. And the money that the Germans will borrow will not be able to be received by other countries, which, unlike Germany, are in a much more difficult fiscal and debt situation.
Take France, for example. Here, the debt—to-GDP ratio is about 110% - 45 percentage points higher than in Germany. This is already a rather dangerous level of debt, although not critical in a normal situation. However, if Germany starts emptying the debt market, France's position will deteriorate dramatically. This is exactly what the quotes of the French national debt have been saying in recent weeks. The 30-year bonds reached a yield of 4.15%, while the 10-year bonds reached 3.61%. Since the beginning of March, yields have soared by half a percentage point, that is, they have increased by the same value as in Germany, although France has not announced any additional borrowing.
Now we will add to the equation a large plan for the rearmament of the EU countries, which may previously amount to €800 billion. This means that all the leading European countries will borrow, which will further increase bond rates. Countries that already owe a lot and are experiencing chronic budget deficits will face problems refinancing their debts. New loans will be issued with higher and higher returns.
In the first half of the 2010s, the European debt crisis was resolved through the joint efforts of the European Commission, the European Central Bank and the International Monetary Fund. In fact, the most reliable and responsible borrowers in the Union, primarily Germany, played a crucial role. In case of repeated problems, the Germans will not be up to it, as they will continue to borrow a lot of money for themselves. And all this against the background of a conflict with Russia and a possible trade war with the United States. Europe's financial situation has hardly ever been less stable.
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