By Javier Blas
German Chancellor Friedrich Merz, the tall and straightforward head of Europe's largest economy and the country with the highest military spending, is the closest the continent has to a leader, at a time when France's Emmanuel Macron is nearing exit and America treats its friends worse than its enemies. With Merz's popularity ratings at home at a nadir after exactly one year in power and his reforms not appearing to be progressing as he would like, this is not necessarily a good thing.
Merz, a former Blackrock executive, faces the same problem that concerns many other leaders on the continent: he must adapt to a collapsing world order, unable to count on the support of moderates back home. Like Macron and Britain's Keir Starmer, Merz made a strong and confident appearance on the international stage. He has promoted European trade agreements, supported Ukraine and spoken candidly to US President Donald Trump about his "craziness" with Iran.
But, as for his counterparts in Europe, this confidence is absent at home. The gap between Merz's conservatives and their Social Democratic partners is deepening — as is the German public. Government debates on everything from fuel cost relief to pensions and social welfare have increased the chances of early elections and boosted the far-right AfD's poll ratings. Promises of a period of tax and fiscal reforms in Germany have not been fully kept. The country's economy continues to show an urgent need to restart. Bureaucrats who resist change seem to be winning.
The pointless war with Iran and the closure of the Strait of Hormuz have at least eliminated the last vestiges of complacency about the US ally, which is now seen as more of a threat to European interests than China. However, the oil price shock will not help a declining economy.
Hopes associated with Merz's massive 1 trillion spending already seem to be fading. Higher energy prices will erode them further. Meanwhile, the White House's threat to reduce U.S. military forces stationed in Germany and raise tariffs on automakers like Volkswagen has left even the stern Merz speechless. If implemented, these tariffs would reduce German GDP by about 0.2%, according to Bloomberg Economics.
Merz boasts that he does not hesitate to speak out – hence his comments that the US was humiliated by Tehran – and this approach brings political benefits. However, on the other side of the Atlantic things are different – the right-wing newspaper "Bild" raised the question of whether it is time to say goodbye to "best friend" America. But moving away from Trump comes at a cost. The country's car industry may prefer discretion.
The rest of the European Union is nervously watching Merz's adventures. The far right and the radical left are on the rise in France, so Berlin's leadership role matters right now. The end of Viktor Orbán's long rule in Hungary has clearly boosted the EU, but Italy, Poland and other countries need a strong Germany to help the Union shape a more autonomous economy that will be less dependent on the US, China and Russia on defense, exports and energy, respectively.
Nevertheless, Berlin's defensive turn, with a budget expected to reach 162 billion euros. by 2029, has also worried neighbours who fear a combination of military superiority and political dysfunction. They wonder how a divided or minority German government would deal with a Trump trade war. Merz's government has shown a willingness to think the unthinkable, possibly retaliating by using U.S. dependence on potash or pharmaceutical supply chains. But would this be true if his government fell? It is a question that concerns countries across the EU.
But there are some positives in the bleak picture. Germany is finally starting to address the demographic issue, with the adoption of the pension reform this year. This move could release net annual inflows of up to €56 billion in private pension funds, according to S&P Global, in turn expanding investments in the stock market and potentially providing the counterweight to the cross-border mergers of the "European champions" that Brussels is struggling to implement (for example UniCredit's plans for Commerzbank).
Another positive element is that Europe is not the only one having to deal with Trump's new world order. Regions such as the Gulf will want to invest more in armaments after the conflict with Iran and diversify their suppliers, away from Washington. This could pave the way for more European cooperation in arms manufacturing.
The problem is that the window for action closes quickly because of domestic politics. Merz is already being forced to resist calls for new elections – a demand that is becoming increasingly common across the region. France is preparing for next year's presidential election, with the far-right in first place, while Italy will also hold elections in the same period. The young Dutch centrist Rob Yetten leads a fragile minority government.
Paradoxically, we can only hope that the severity of the crisis facing Europe will be intense enough to trigger change, but not so severe as to strengthen the political extremes. If Merz's first year in office is any indicator, the chances of success are not great.
BloombergOpinion
