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This article has been automatically translated from Dutch. Click here to see the orginal article including all links to sources.
This week, we witnessed a historic German shift in fiscal policy and saw that EU defense plans are further pressuring the foundations of our euro’s stability. As billions in new debt are announced for weapons and infrastructure, budget rules quietly disappear. Are we at the beginning of the end of the euro and the European welfare state?
The European Central Bank (ECB) lowered its policy rate by a quarter percentage point to 2.5% on Thursday. According to the well-known Taylor Rule, this cut was unwarranted. This is the lowest policy rate since February 2023. The ECB stated that monetary policy is becoming noticeably less restrictive, making new loans cheaper for businesses and households and stimulating credit growth.
ECB Rate Cut (source: Holger Zschaepitz)
The decision follows particularly weak economic growth figures and a decline in eurozone inflation to 2.4% in February—slightly above the expected 2.3% and still above the 2% target. In Q4 2024, eurozone GDP grew by just 0.1% compared to the previous quarter. In the Netherlands, inflation is significantly higher. CBS reported that Dutch inflation rose to 3.8% in February. This suggests ECB policy is too lenient for the Netherlands. "Unwise," said Lex Hoogduin regarding the rate cut, though this wasn’t the main critique of the week.
Inflation in the Netherlands (source: CBS)
There is growing criticism of the EU's direction. This week, Ursula von der Leyen launched a plan to invest €800 billion in European defense and infrastructure. The plan, called ReArm Europe, will be funded with new debt. We published an article on the plan this week. Several countries, including France, Spain, and Italy, have long advocated for eurobonds—shared debt. But it doesn’t stop there.
The European Commission now wants to activate the escape clause of the Stability and Growth Pact (SGP). According to the SGP, member states must maintain deficits below 3% of GDP and debt below 60% of GDP. Failure can lead to sanctions and fines. Several countries, including France, Italy, Belgium, and Hungary, are currently under such procedures. The escape clause allows temporary suspension of these rules in emergencies. It was previously activated until the end of 2023 due to the pandemic.
Christine Lagarde, ECB President (source: Martin Lamberts/ECB)
Lex Hoogduin sees this as the effective abolition of the SGP and a step toward a Latin Monetary Union. "The SGP is essentially being thrown away," said Hoogduin. He views this as undermining euro stability and sustainability. He criticizes an ECB that ignores problems and dodges valid questions. He attributes this to a scheme by Von der Leyen and Lagarde, who previously worked closely together.
Economist Edin Mujagic responded sharply: "Unbelievable," he said. He believes this move will structurally fuel inflation. Mujagic agrees with Hoogduin that Von der Leyen’s defense plans spell the end of European budget rules. While acknowledging defense's importance, he argues the spending should be offset by government cuts through a Musk-like operation, not more debt.
Even from "the most right-wing Dutch government ever," there is no resistance. Finance Minister Schoof appears to support the relaxation and the additional €150 billion in loans from Brussels, guaranteed by the Netherlands. This despite a recent parliamentary motion opposing European defense bonds. Former MEP Rob Roos commented on X: "We’re guaranteeing countries that have been bankrupt for over ten years."
French President Emmanuel Macron addressed the nation, assuring Ukraine of support and signaling France's ambition to lead in European defense and the nuclear umbrella, as the U.S. seems to step back. ZeroHedge sees a power struggle brewing between France, Germany, and Poland for Europe's leadership.
French President Emmanuel Macron (source: France Diplomatie)
Macron declared the EU's budget rules obsolete. His speech is closely tied to France’s economic struggles, including persistent deficits and high national debt. Political reforms seem nearly impossible. France has strong interests in relaxing budget rules and supports shared European debt. Former MEP Michiel Hoogeveen noted that a war economy particularly benefits French industry, as France is one of the world’s largest arms exporters.
Chancellor-designate Friedrich Merz announced plans for a €900 billion mega-investment in defense and infrastructure, proposing to abandon the debt brake. According to NOS, the plan faces resistance, even within Merz's party. Merz campaigned on preserving the debt brake, the issue that toppled the previous coalition. This would be the largest debt package in modern German history.
Germany has been struggling with economic stagnation. This week, factory orders dropped 7%. Politically, this shift comes at a convenient time. Merz justified the move by citing Trump and Ukraine, seeking to lead Europe alongside Macron.
After decades of conservative fiscal policy, this marks a "whatever it takes" moment. Germany’s debt may soon surpass Italy’s. No surprise, then, that German government bonds had their worst day since the fall of the Berlin Wall. The yield on 10-year Bunds jumped 30 basis points to 2.8%.
German Bond Yield Surge (source: Bloomberg)
Stock investors reacted by shifting funds from the U.S. to Europe, especially Germany. Defense stocks like Rheinmetall and Airbus performed well, as did automakers. French defense firms like Thales also thrived. Some expect the ECB may soon have to tighten policy due to Germany’s sudden spending spree. Consequently, the euro appreciated, and German inflation expectations rose above 2%.
Italian Bond Yields (source: Jeroen Blokland)
Germany’s radical fiscal pivot also drove up rates across Europe and even in Japan. Economist Daniel Lacalle sees this as fear of unlimited government spending and persistent inflation. Italian bond yields rose above 4%. Jeroen Blokland explained on X that German rates anchor all other European rates. French and Italian yields will always be higher due to credit risk. If Germany follows through on these plans, expect immediate stress elsewhere.
The looming question is what all this means for the European welfare state. Europe's welfare systems were built partly thanks to the U.S. defense umbrella—a subsidy now fading. Rising defense, infrastructure, and interest costs must come from somewhere. Meanwhile, welfare spending grows due to an aging population. Will politicians shift the burden to the future with debt, subtly tax citizens through inflation, or raise taxes further? It appears all of this may happen. Next week, we’ll release a podcast on rising taxes in the Netherlands and an exit tax.
Pension Spending as a Percentage of GDP (source: Eurostat, via Michael A. Arouet)
Whether it’s possible without cutting the welfare state remains doubtful. Interest rates and inflation will keep rising, leading to unrest. Above you can see how much of each economy goes to pensions. In many European countries, it’s over 10%, and that's just pensions. Unsurprisingly, The Financial Times published an article titled: "Europe must trim its welfare state to build a warfare state."
One way or another, we are heading into a period of political unrest and likely rising inflation. That’s why saving in an asset that protects against this makes sense. Historically, that role has belonged to gold.
