Why is Germany joining the high-debt party?

Germany has finally decided to join the party — but Europe may come to regret it. After two decades of limited borrowing and fiscal restraint, Europe’s biggest economy is finally joining the high-debt club. Incoming chancellor Friedrich Merz will borrow $860 billion, and perhaps much more, to pay for extra spending on defense and infrastructure.

Sure, Germany needs to spend more on its armed forces and on restructuring its economy. But it will also likely mean the eurozone no longer has a single solvent member to anchor it. It is hard to see how this situation will end well for Europe.

Merz is a center-right, pro-business leader, but you might not know that from his decision to start borrowing on a massive scale. The constitutional debt brake will be suspended for military spending above 1 percent of GDP. It is perfectly easy to make a political case for Merz’s focus on defense spending. Donald Trump’s rhetoric means that Germany needs to spend more, and it would be hard to raise taxes sufficiently to pay for the things the government needs to do.

The problem is this: the plan could add up to 25 percent or more to the country’s debt-to-GDP ratio. If so, this will take Germany from its current 62 percent, a remarkably low figure for the developed world, to close to 90 percent. If it carries on this path, Germany risks getting closer to France, which has a debt-to-GDP ratio of 112 percent, or indeed Italy of 135 percent.

In Berlin, the decision to borrow huge sums of money makes some sense. Just as if you are at a dinner where everyone is splitting the bill equally, there is no point in ordering a cheaper dish (in the economics textbooks, there are whole chapters on what is known as “the diner’s dilemma”). It never made much rational sense for Germany to be the only fiscally responsible country in a monetary union addicted to debt. The trouble is this: if the EU comes unstuck, who will step in to help?

Germany has always been seen in the bloc as a backstop that could bail out other members when disaster struck. Now, it could be just as heavily in debt as its neighbors. Investors have already started to worry about the consequences: yields on German debt have risen sharply. So while Merz is winning plaudits for his decision to splash out, Europe should not be celebrating: the eurozone has lost its guarantor. There could be trouble ahead.