Making Germany Great Again plus other revolutionary ideas

Thoughts on why Starmer kissed Trump's ass, Merz's unfortunate start, can the euro grab some exorbitant privilege, who's afraid of German rearmament, and who wins from Trump's Cultural Revolution-lite

Photo by Christian Wiediger on Unsplash

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In this newsletter:

• Kissing Trump’s Ass: What was in it for Starmer?

• Merz’s Unfortunate Start: Three tests for the new chancellor

• Euro-Vision: Seeking exorbitant privilege

• Making Germany Great Again: Who’s afraid of German rearmament?

• Trump’s Cultural Revolution: Brain Drain

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1. Kissing Trump’s Ass

Thank goodness for the Special Relationship! It is a mark of just how badly both sides needed the half-baked US-UK trade deal that was unveiled last week that it was announced barely 12 hours after Sir Keir Starmer had to be hauled away from watching an Arsenal match to take a phone call from Donald Trump. The two leaders then staged a bizarre press event in which the prime minister, interrupting Britain’s VE Day 80th anniversary commemorations, was patched into an Oval Office meeting from a conference room in Birmingham.

It is easy to see what was in this for Trump. The US president has been under enormous pressure to demonstrate progress in walking back the Liberation Day tariff debacle. The S&P 500 has rallied more than 13 percent over the past month since he announced his 90-day pause on “reciprocal” tariffs. Yet despite his claim to have personally negotiated 200 trade deals, he had nothing to show for them. He said he had 75 world leaders wanting to “kiss his ass”. Where were they?

Enter Starmer. The prime minister had his own reasons to want a quick deal. His party had been trounced in local elections the previous week, in part reflecting voter frustration over the economy. Despite record tax rises last year and £5 billion of welfare cuts in March, Britain’s fiscal position remains precarious. The National Institute of Economic and Social Research, a think-tank, reckons that the government is likely to have to find £60 billion before the next election to meet her fiscal rules. Getting relief from Trump’s tariffs was thus a priority.

In the end, the deal announced didn’t even do that. The 10 percent baseline tariff that Trump introduced on April 2 remains on all UK exports. And as Politico noted, even the new 10 percent U.S. tariff on cars (down from the 25 percent since April — but still up from the 2.5 percent since before April) applies just to the first 100,000 cars British firms send to the U.S. each 12 months. In fact, the U.K. has often sent far more than 100,000 cars in recent years.

Many details, including how tariff exemptions on steel will work in practice, remain unclear. As Simon Evenett notes, the documents provided by both sides are full of contradictions. The package is simply a framework whose details could take months to finalise, leaving it vulnerable to Trump’s whims and coercion.

The flimsiness of the deal didn’t stop markets rallying, perhaps taking their cue from Trump, who told the news briefing: “You better go out and buy stock now.” But it is hard to see why. To the extent the deal contained any useful information, it was that the 10 percent baseline tariff is here to stay, confirming that Trump remains wedded to his protectionist agenda. That’s hardly reassuring.

Besides, it is hard to see other countries rolling over so easily. Indeed, Commerce Secretary Howard Lutnick seemed to confirm as much, warning of negotiations with Japan and South Korea that “these are not going to be fast deals.” The EU last week outlined a series of retaliatory measures it might take if Trump refuses a satisfactory trade deal. And even if this weekend’s negotiations with China lead to de-escalation, a full-fledged China trade deal could take years to pull off.

Why was Britain willing to accept such a bad deal? Part of the answer is that the government recognised that Trump is committed to his protectionist agenda, and given its lack of leverage, considered it better to engage in damage limitation. Who knows, perhaps the nauseating flattery of Trump at the announcement will pave the way for further concessions in the continuing negotiations.

But the deal serves a political purpose too. Days before announcing the US agreement, Starmer signed off on a much more ambitious UK-India trade deal. That means that in barely a week, Labour has delivered on two of the most-deeply cherished goals of Brexiteers who saw deals with the world’s first and fifth largest economies as core to their vision of “Global Britain”.

Even if the Tories have made themselves look even more ridiculous than they were already by coming out against both deals, Starmer has bought himself political cover for what would be by far the most significant trade deal of all: a bold reset of Britain’s relations with the EU. Indeed, the government signalled that this is where its priorities lie by making clear to the Americans that it would not agree to any terms that would jeopardise closer trade with the EU.

Let’s hope that a bad deal with America is the price to be paid for an EU reset to be launched at the UK-EU summit on May 19 that beats current low expectations.

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2. Merz’s Unfortunate Start

Friedrich Merz could hardly have got off to less auspicious start. Not only did the new German chancellor become the first in the history of the republic to fail to secure the post in the first vote in Bundestag, when 18 members of his own coalition refused to back him. Worse, since the vote was secret, Merz has no idea whether they were members of his own Christian Democrats unhappy at his dramatic post-election U-turn on Germany’s debt brake, or disgruntled members of the Social Democrats still angry at his pre-election breaking of a long-standing taboo when he joined forces with the far right AfD in a vote on immigration.

People who know Merz well tell me that he is remarkably resilient and will take his blow to his authority in his stride, as he did the many setbacks in his long march to the chancellorship. He has since got off to an energetic start, with trips to Paris, Warsaw, Brussels and Kyiv. Nonetheless, the vote was a reminder that this polarising politician, who takes office with an approval ratings of just 36 percent, has plenty of enemies even within the ranks of his wafer-thin majority.

That’s important because expectations for the Merz government are ridiculously high. At the start of the year, I noted how investor attitudes towards Europe were too gloomy. Since then, they have dramatically reversed. The DAX40 index of leading German shares is close to its all-time high, having outperformed the S&P500 by a remarkable 20 percent this year. German government bond yields are back where they were before the reform of the debt brake. Much of that reflects expectations that German spending will cushion the impact of Trump’s tariffs.

Of course, such a giant increase in borrowing - the debt brake reform will establish a new €500 billion fund for infrastructure spending and allow unlimited defence spending - is bound to lift growth. Although how far and how fast depends on how and when and where all the extra money is spent. But from an economic perspective, how transformative the Merz government will be also depends on how it responds to three challenges:

• Can it deliver long overdue structural reforms to ensure the increased spending leads to lasting improvements to productivity? These include cuts to Germany’s sprawling bureaucracy, reforms of the pension and welfare systems to provide greater incentives to work, and reforms to planning rules to speed up the construction of infrastructure. Merz has raised hopes by appointing two respected business leaders to his cabinet. But the coalition agreement contained little detail on reforms, reflecting an ominous lack of political consensus. The SPD will be particularly resistant to welfare reforms.

• Will Merz back long overdue reforms at the European level to improve the productivity of the single market? The challenges here were set out with brutal clarity in the reports last year by Enrico Letta and Mario Draghi. Indeed, Draghi has noted that for all the anxiety about Trump’s tariffs, the EU’s own internal barriers to trade are the equivalent of a 45 percent tariff on goods and 110 percent on services. Again, Merz has raised hopes of a more constructive approach after the disappointment of the Scholz government which was hamstrung by internal divisions. He has given his backing to the proposed Savings and Investment Union, which is vital to improve access for growing European companies to finance. But the fact that he opposes completion of the banking union and the proposed takeover of Commerzbank by Italy’s Unicredit, suggests his pro-European instincts have their limits.

• Will Merz will agree to common European borrowing to help pay for increased defence spending? The new chancellor has been commendably robust on the need for German rearmament and in his support for Ukraine. But as I noted in a previous post and in a piece last week for The Guardian, any serious European rearmament plan needs to be underpinned by a common fund, both enable some of Europe’s more indebted countries to play their part, but also to help overcome the deep fragmentation in the European defence equipment market. Yet it seems highly unlikely that those members of the CDU already unhappy with Merz over easing of the German debt brake will back further issuance of debt at the EU level.

That suggests the risk for investor disappointment is high. Much is riding on members of the new coalition rising to the urgency of the moment and resisting future acts of self-indulgence. The alternative is that Germany ends up with a wasted moonshot and Europe with only half a Zeitenwende.

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3. Euro-Vision

Another reason for Europe to embrace common borrowing for defence is not just that it will increase its strategic autonomy but can help boost its financial autonomy too. As Paolo Gentiloni, the former Italian prime minister and European Commissioner for economy, noted in a speech last week, the EU should promote more ‘homogeneous’ supranational debt issuance to capitalise on international demand for euro-denominated ‘safe assets’ and take advantage of the ongoing flight by global investors from dollar assets.

There was further evidence of the de-dollarisation trade in the extraordinary currency moves in Asia last week, as investors sought to shield themselves from wild recent swings in the dollars. As the Financial Times reported:

Taiwan’s dollar has surged almost 6 per cent against the greenback this month, posting the biggest single-day moves since the 1980s, while Hong Kong’s monetary authority spent the largest weekly amount since 2020 to stop the city state’s currency strengthening beyond a US dollar peg.

“It is not even once in a decade — it has been a once in a lifetime event. It has been an extraordinary move” in the Taiwan dollar in particular, said Mark Ledger-Evans, a portfolio manager at emerging markets investment firm Ninety One.

The moves reflected uncertainty over what Chinese manufacturers, Taiwanese insurers and other Asian investors will do with the trillions of dollars of US assets built up due to surging exports to the US. These assets are now hostage to a weakening greenback.

The Trump administration is clearly rattled by the growing debate in the markets about the dollar’s safe haven status since senior members of the government went out of there way last week to talk up America’s friendliness to foreign capital. Stephen Miran, the author of the notorious Mar-a-Lago Accord plan, which proposed taxing foreigners on their holdings of US Treasuries and forcing them to buy perpetual bonds, insisted last week that “in the fullness of time, capital will flow to where the opportunity is, and we’re creating those opportunities.”

Meanwhile Scott Bessent, the Treasury Secretary, had many people frantically searching the web last week when he referred to America as “the Schelling point of global finance.” According to Bloomberg:

Bessent was invoking the late Nobel laureate in economics, andnoted game theorist, Thomas Schelling. The Schelling point describes an intuitive answer that multiple parties land on without coordinating.

Dollar-based assets are the focal point the world turns to, in Bessent’s telling at the Milken Institute. “We have the world’s reserve currency, the deepest and most liquid markets, and the strongest property rights.”

It is easy to see why the Trump administration is so rattled by the loss of confidence in the dollar. For decades, America as the provider of the global reserve currency has benefitted from “exorbitant privilege”. In other words, the seemingly inexhaustible demand from global investors for dollar-denominated assets has allowed America to fund its twin budget and current account deficits at much lower interest rates than would otherwise be the case.

A new report by Deutsche Bank has attempted to quantify what this exorbitant privilege is worth. It reckons that the US has been able to accumulate an extra 25 percent of GDP in debt without any increase in its borrowing costs. It also detects a decrease in this exorbitant privilege since April 2.

That does not mean that the dollar is about to lose its global reserve currency status. But it does suggest that the euro could capture some of this exorbitant privilege itself, if it focused on making the currency zone more attractive to international investors, including by increasing the supply of “safe assets”. At a time when Europe faces huge fiscal pressures to fund increased defence and the energy transition, a bit of exorbitant privilege is well worth having.

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4. Making Germany Great Again

There’s another reason why Merz should embrace common European defence programmes and deeper European military integration as part of his rearmament programme. At the moment, everyone is relieved that Germany appears finally ready to shoulder its responsibilities to European security. But this recent piece in Foreign Affairs by Michael Kimmidge and Sudha David-Wilp raises important but uncomfortable issues that could be too easily overlooked:

Germany’s highest ideal is still a Europe without war, but now the country is rearming so it can make its own decisions. Former Secretary of State Henry Kissinger once described Germany as being “too big for Europe, too small for the world.” The country will never be a global superpower, his thinking went, but it cannot avoid having a dominant position within Europe. Germany has Europe’s largest population and economy. Should it also acquire a powerful military, it could become a regional hegemon—or risk being seen as one.

A rearmed Germany will remain a force for good only if its government can avoid falling into the hands of ultranationalists. For generations, Europe has known a Germany that is unwilling to use military force. Having lived through the horrors of extreme nationalism in the 1930s and 1940s, Germany had no desire to fight or inflame tensions with its neighbors. Yet nationalism can be contagious, and charismatic leaders can take it in unpredictable directions. It is already ascendant in places as disparate as China, India, Russia, and the United States.

A rearmed Germany could unsettle its neighbors. Other European countries already criticize Germany for throwing its financial weight around in Brussels. A more broadly powerful Germany might provoke the rise of nationalism in nearby countries beyond Russia, and greater nationalism in Germany’s vicinity could, in turn, fuel nationalism within Germany itself. And a German military first strengthened by politically centrist, pro-European governments could fall into the hands of leaders willing to relitigate Germany’s borders or to forgo EU-style deliberation in favor of military blackmail.

If the US is retreating from Europe and reducing its security umbrella, what fills the vacuum will become profoundly important. The more deeply integrated all the continent’s militaries in common structures, the better.

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5. Trump’s Cultural Revolution

Could Europe profit from an American brain drain as a result of Trump’s war on American universities? European Commission President Ursula von der Leyen certainly hopes so. Last week, she unveiled “Choose Europe for Science” a €500 million ($569 million) initiative to woo foreign researchers, pointedly declaring that: “Science has no passport, no gender, no ethnicity or political party.” At the same event, French President Emmanuel Macron committed another €100 million to France 2030, which aims to lure researchers and make France a science “safe haven.” Canadian universities are making similar efforts.

What must be true is that there are risks to America’s long-term productivity, innovation and tech leadership if Trump’s actions end up driving academics and students elsewhere. I wrote about this in an essay for Bloomberg. Perhaps the most extreme brain drain in modern times was in Communist China during Mao’s Cultural Revolution. In 1965, when Chinese scientists forged their first integrated circuit, China’s chip industry was only half a decade behind the US. But 10 years later, it had not only fallen far behind the US but much of Asia:

What had happened in that intervening decade was the Cultural Revolution, when Mao Zedong effectively declared war on China’s educated elites. The Communist Party chairman argued that expertise was a source of privilege that undermined socialist equality. Thousands of scientists and experts were sent to work as farmers in destitute villages; many others were simply killed.

Of course, Trump is not threatening to send anyone to the paddy fields, only to withdraw their grants and funding, revoke their visas and tax their university’s endowments. But history is replete with other brain drains that have had lasting consequences for country’s productivity, including in post-war Britain (which is where the term originated) and again in post-Brexit Britain. Meanwhile China itself is now vying for global tech leadership with America thanks to universities rising up the global rankings, ironically fuelled by scientists trained in America in what has been dubbed the “reverse brain drain”.

As I say in the piece, the lesson of history is that revolutions once started can be hard to stop. That, of course, applies to every topic covered in this newsletter.