Key Takeaways from Berlin – ‘The Dawn of a New Era’

Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA

Geopolitics – The Dawn of a new Era

Ever since Russia’s unlawful and unprovoked military invasion of sovereign and independent Ukraine in early 2022, the economic globalization as we knew it, and peace dividend since the end of the Cold War in 1989 are over for good. This means nothing less than in global affairs, politics and security are ranking above trade and business marking the dawn of a new era.

The ‘Realpolitik’ consequences of this paradigm shift is the Global West decoupling from Russia and de-risking from China. The big difference between economic mignon Russia and economic superpower China is Russia’s revanchist and revisionist political and military power with imperial ambitions and phantom pains, whereas China is globally hugely relevant but will, hopefully, thrive to assume geopolitical positioning and responsibility within the existing multilateral framework and rules laid down by the likes of the UN and WTO charters.

There is unwavering determination on the part of the Global West led by the US, the Europeans and NATO to restore ‘whatever it takes’ Ukraine’s territorial integrity and to hold the aggressor Russia accountable.

It is highly unfortunate that not only China but also big powers such as India and Brazil are still fundamentally misjudging the principled zero tolerance in Europe for any military aggression to move sovereign borders by force in unilateral violation of international laws.

Furthermore, outside powers complicit or benefiting directly or indirectly supporting Russia risk facing serious political and economic repercussions down the road. Sanctions not only have moral motivation, but more so a political, legal, economic and security dimension.

Germany’s ‘Zeitenwende’ – Walking the Talk

Ever since Chancellor Scholz’s ‘Zeitenwende‘ speech delivered to the Bundestag on February 27th 2022 – just 3 days after Russia’s invasion of Ukraine – Germany has been an integral part of the immediate, massive and unified European political, security, economic and humanitarian response to Russia’s entirely unacceptable attack on the European post WWll order.

Finally we see the end of Germany’s longtime misguided ‘Ostpolitik’ (‘Wandel durch Handel’) and fatal energy dependence on Russia’s oil and gas supplies, driven by a few key factors and unholy alliances of socialist and far right politicians, selected big business’ interests and various German-Russian lobby groups often linked to former East German and Russian security services.

All the more insightful and positive are German opinion polls after Russia’s attack on Ukraine consistently showing a vast majority of the German population strongly supportive of energy decoupling, economic sanctions, military support and humanitarian aid to Ukraine, strongly signaling that Germany’s leadership was lagging throughout.

By now, there is no doubt that the German Government and a big majority of the population are fully committed to this historic and just cause of supporting Ukraine, paving the way for Ukraine joining the EU and NATO, once necessary accession criteria are met.

European Banking Union – Crisis as an Opportunity

Unfortunately, Europe continues to suffer fragmentation and structural deficiencies in the field of competition of European banks and capital markets. The blame for this longtime pitiful and economically expensive state of affairs doesn’t go to European policymakers in Brussels nor the ECB in Frankfurt but to the guardians of national champions, vested interests as well as lobby groups in the respective national capitals, particularly Berlin and Paris.

The reason why the US banking system and capital markets have been more efficient in capital allocation, profitable for its stakeholders, rewarding for investors and growing in absolute and relative importance is largely due to the sheer size of its domestic market, same level playing fields regulated by common rules and the USD being the dominating world’s trade and reserve currency.

The recent self-inflicted demise of Swiss lender Credit Suisse has laid bare the many coinciding failures of Swiss policymakers and the bank’s leadership alike. Little surprising in the aftermath of the Credit Suisse’s casualty jitters across the European banking landscape were felt with weaker players such as Deutsche Bank particularly affected. The similarities are indeed striking – as Deutsche Bank has been running a structurally even less profitable business model and strategy than Credit Suisse and BAFIN is, similarly to FINMA, not up to the task of supervising a globally systemic bank.

Clearly, the base case is to expect European banks to underperform continuously while more efficiently and better managed US banks continue to strive. The worst case, however, are more banking casualties in Europe. This might be a blessing in disguise as progress in regards European banking union and cross border consolidations seems to be possible only as a result of a major Eurozone bank casualty.

European Capital Market and Fiscal Union – Quantum Leap in Waiting

Clearly, European countries including Germany are facing a very challenging fiscal environment and related financing obstacles ahead. The post 1989 Cold War peace dividend has been spent and, now, the peace has gone, too.

In Germany, as in other European countries, successive governments have wasted the peace dividend over the past three decades in social spending, subsidies and consumption instead of investment in productive capital.

Governments are now facing the lamentable situation of having to finance the energy transition, the rehabilitation of defense capacities and investment in public transportation infrastructure – just to name the crucial ones. A sustainable solution to unprecedented sovereign debt levels, aging populations and pressures on public budgets has three dimensions:

• engage in structural and market-oriented reforms to facilitate growth and increase productivity by attracting investment, businesses and qualified people

• cut economically harmful subsidies entirely and reduce social spending to absolute necessities

• increase indirect taxes on consumption and negative externalities on society like pollution, sugar etc.
  
  

The common currency EUR is an unparalleled success story and should be completed with the creation of a full capital market union. Whenever Brussels had to face financial crisis – be it because of sovereign debt emergencies/Greece or COVID pandemic/NextGenerationEU – there was responsible and bold action guided by institutional progress. A true European capital market union would create a massive pool of liquid assets, efficient capital allocation and attractive Eurozone sovereign fixed income instruments to raise capital for investment purposes.

The lack of a capital market union has prevented the EUR from progressing as a global trade and reserve currency in the past decade and keeps its role massively below potential.

German Investment Outlook – Resilience and Opportunities

Doomsayers on Europe, and Germany in particular, got it wrong again. Respective economies have proven resilient facing adversity. In 2023 German and French stock markets so far have been global top performers in absolute and relative terms.

Clearly, the political, security, economic, business and investment road ahead to a new multipolar equilibrium will be fractious and hazardous. Policymakers and businesses alike need to keep an open mind to manage through a prolonged phase of creative destruction. Great prosperity and fortunes can be created (and lost) – just remember the transformative 1930s, 1970s and 1990s.

Germany, Europe’s largest economy, is well positioned to tap emerging opportunities. On a domestic level, however, it will have to trust superior market-driven solutions rather than red tape and subsidies. They finally must invest in overdue infrastructure projects (transportation, education, defence, alternative energy) open up to qualified immigration and support the transfer of selected political power from Berlin to Brussels or Frankfurt – particularly, in the areas of banking and finance, energy and aerospace & defence.