Even Elon Musk Can't Save Germany

VIDEO TRANSCRIPT

The November US elections were transformative.

Will we say the same about the German federal elections in 2 weeks?

Why does Elon Musk say that Germany, the third largest economy in the world, needs to move beyond its guilt about its past ?

Why has an unsuccessful political gamble last week by the main German opposition party  may have cost Germany a precious opportunity to make a decisive break from failed policies?

Should you be investing in German assets or buying the euro right now?

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We are barely a month into the year, but it is already pretty clear what kind of year 2025 will be.

Everything is pointing to a year of heightened if not extreme policy uncertainty.

The global economic policy uncertainty index, which spiked in December, is now at its highest level since the height of COVID. (Chart 1)

Indeed, even during Donald Trump’s turbulent first term the index was never remotely as high as right now. (Chart 1)

Policy uncertainty raises risk to economic growth, as it tends to discourage household consumption and business investment. (Chart 2)

A new IMF study argues that these effects also can be amplified by high public and private debt. (Chart 2)

My guess is that we will soon see the impact of the big jump in global policy uncertainty showing up in economic data.

The decline in the JP Morgan composite global purchasing managers’ index in January - for the first time in four months - could be a harbinger of what’s to come (Chart 3)

Some people take heart in the fact that manufacturing output and new orders moved back into expansion territory in January (Chart 4)

I am more skeptical only because the data are likely flattered by the fact that many American companies were stocking up after the US elections to get ahead of Trump’s tariff war. (Chart 5)

My gut says that the pickup in global manufacturing activity will be short-lived.

I am inclined to give more weight to what is happening in the service sector

In this respect, I see the slump in the global PMI for services in January, to the lowest level in a year, as a clear sign of trouble ahead (Chart 6)

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Economic performance varied across countries and regions in January.

Manufacturing PMI picked up in Europe, the US, and India but slipped in China.  (Chart 7)

In contrast, service PMI fell in most countries, except for Germany, Japan and Russia (Chart 8)

Interestingly and a little unexpectedly, Germany was the only major country that saw both its manufacturing and service PMI go up in January. (Chart 8)

Whatever this may signify, it clearly got the attention of the market.

The Germany stock market is currently the second-best performing stock market year to date, after Brazil (Chart 9)

DAX has been literally going up in a straight line. (Chart 10)

Investors are piling into German stocks:

Despite the fact that the German government last week slashed its growth forecast for 2025 to just 0.3%. (Chart 11)

Despite the fact that policy uncertainty in Germany is currently the highest among the largest economies in the world, even higher than in Canada and France (Chart 12)

Despite the fact that German consumers are still holding back, evidenced by the big drop in German retail sales in December (Chart 13)

If there is anything to cheer, Germany’s machinery orders from abroad rose sharply in December, after a very tough year (Chart 14)

Investors may be hoping that faster economic growth in the rest of the world will help breathe some life into the German economy.

They may be also seduced by the fact that Germany is ostensibly cheap.

The euro is trading barely above parity against the dollar. (Chart 15)

And DAX is trading on an estimated forward P/E of 16 times versus 25 times for S&P 500. (Chart 16)

Will Germany prove the market right?

Or will it get even cheaper?

This is the million dollar question.

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The relative decline of the German economy is not news.

It has been going on for the past 10 years.

What is new is the pace of this decline

Since COVID and especially after the start of the Ukraine war, the German economy has barely grown.

As a result, its per capita income has been steadily falling behind the likes of the US

The standard of living of an average German is now more than 20% lower than that of an average American (Chart 17)

Germany may enjoy higher income equality than the US, but these days German per capita GDP is barely above that of Mississippi, the poorest US state, measured in US dollar and in current price (Chart 18)

The decline in Germany’s relative per capita income reflects the fact that since COVID, German labor productivity growth has been lagging BEHIND that of other countries (Chart 19)

Among major developed economies, even Japan and the UK have done better than Germany and only France and Australia have done worse (Chart 19)

Labor productivity growth is a measure of competitiveness.

The implication is that Germany has lost competitiveness.

This is also evidenced by the loss of market share of German exports.

Since the start of COVID, Germany’s share of global exports has fallen more than 1 percentage point to below 7%. (Chart 20)

Since 2022, Germany’s share of global exports has fallen decisively lower than that of the US. (Chart 20)

Why has Germany fallen on bad times?

It is very simple.

Germany has been the primary victim of US foreign policy over the past 8 years.

US tariffs on China introduced during Donald Trump’s first term forced China to accelerate its transition to higher value-added manufactured products. (Chart 21)

This resulted in greater Chinese competition for German produced goods.

German exports to China, Germany’s largest export market, suffered.

In car sales, BYD overtook the long time Chinese market leader Volkswagen in 2023

In 2024, the gap between the two widened further with BYD’s sales in China increasing by 37% while VW’s sales in China falling by 7%.

If US foreign policy under Trump 1.0 was bad news for the German economy, US foreign policy under Biden was worse

The US proxy war against Russia in Ukraine drove up the relative energy price faced by German industries. (Chart 23)

Even now, natural gas price remains 4 times higher in Europe than in the US, compared to 2 times higher at the start of 2018. (Chart 23)

Germany manufacturing, especially the energy intensive industries like steel and chemical, took a massive hit and many companies have been relocating their production to China, the US and elsewhere.

The twin shocks of increased Chinese competition and higher energy price has been more than Germany manufacturing can handle (Chart 24)

A turnaround requires a decisive shift in policies.

Will 2025 finally bring a new political consensus to affect fundamental changes to revive the largest economy in Europe and the third largest in the world?

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The moment of truth for Germany is just two weeks away.

The German federal election to be held on Feb 23 will decide the fate of the German economy, and given the important of Germany to the rest of Europe, the fate of the European economy

I have little doubt that the CDU/CSU alliance will emerge with the most seats in the Bundestag

But as I explained in an earlier video, the crucial question is whether the CDU/CSU will win enough seats so that they can form a coalition government without the Greens. (thumbnail: polarization)

What is at stake is the promise by Frederick Merz, the leader of the CDU, to build 50 gas-fired power plants to help lower energy prices if his party wins the election.

Merz has vowed to restore German industrial competitiveness by reversing the climate policies championed by the current government.

However, In a CDU/CSU and SPD coalition scenario, it would be not be easy to push through his proposals

In a coalition scenario that also includes the Greens, it would be impossible.

Whereas until last week the odds still favored a coalition without the Greens, a new poll published this week suggest otherwise.

This is why:

Since mid-November, the CDU/CSU have been losing ground in the polls, mainly to  the populist right-wing AfD (Chart 25)

This pushed Merz last week to make a gamble that backfired.

He tried to push through a bill to toughen immigration with the support of the AfD.

His decision to seek the support of the AfD, for which he has been accused of giving legitimacy to a party shunned by the mainstream parties, caused a fracture within his own party and a public uproar

Not only the bill failed to pass due to lack of support within his own party, a new Forsa election poll that came out on Monday showed a drop of support for CDU/CSU and a corresponding gain for the Greens (Chart 26).

The poll also shows the Linked, the left party, crossing the 5 percent threshold. (Chart 26)

These developments make it unlikely that the CDU/CSU will contemplate any kind of future alliance, officially or unofficially, with the AfD that also wants to revive the use of fossil fueled based energy.

And, more importantly, it makes it more likely that Merz will be at the mercy of the Greens in his next government.

There is no other way of putting it

What happened in Germany over the past week has further increased economic policy uncertainty, which is already elevated. (Chart 12)

It does not bode well for the recent rally of the German stock market.

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Predictions:

The German economy has been a victim of US foreign policies under Trump 1.0 and Biden

Under Trump 2.0, it will likely get even more difficult

This is because German exports to the US have expanded massively over the past 4 years. (Chart 27)

With the US replacing China as the biggest destination for German exports, Germany’s dependency on the Chinese market has been replaced by dependency on the US market.

This is unlikely to be viewed kindly by Trump.

Indeed, Trump has repeatedly complained about the EU's large trade surplus in cars with the US.

Germany would be very vulnerable to a trade war with the US

Europe could try to placate Trump by increasing its import of expensive US LNG

Or by buying more US defense equipment

While the CDU and CSU support increasing Germany’s defense spending, this will only exacerbate Germany’s fiscal problem without solving its economic problems

Trump said this week that he was open to trade aid to Ukraine in exchange for Ukraine’s natural resources.

The fact that Trump seems no longer in a hurry to stop the Ukraine war could mean that the economic costs of the war will fall increasingly on Europe, especially Germany.

I don’t know what the market sees in the German stock market.

If the election is as close as the latest poll suggests, we could yet see profit taking ahead of the elections.

The US elections last November were transformative for the US.

It is not clear to me that we will say the same about the German elections.

I think there is at least a 50% chance we will just end up with the status quo, namely more debilitating political paralysis.

It doesn’t mean that the euro can’t go up against the dollar this year, but it does mean that if it does it will be because of dollar weakness rather than euro strength.

Elon Musk said that Germany needs to move beyond past guilt, but throwing over historical baggage is always easier said than done.