Transcription
Germany's coalition government just collapsed because the country's prime minister, who famously promised the economy would not fall into recession, now can't agree with his former Finance Minister on how to get out of it. After fighting reality for over a year and ridiculing anyone who dared to point out the gravity of the situation, suddenly the economy now matters.
It certainly does in the marketplace, the real marketplace, not stocks, as Germany's 10-year swap spread just turned negative for the first time ever. This isn't a coincidence. I did a video just yesterday on the warning from US dollar swap spreads that hit record negatives nearly across the board. The vibe session is about to take another major hit after getting pummeled in Tuesday's US presidential election.
In country after country, voters are taking their anger out on incumbents of all stripes. It doesn't matter who is in or what they claim to stand for; as long as they won't admit the economy is terrible, they aren't going to stand for very long. Realizing this is what's behind the German government's current downfall: they waited too long to finally admit the truth, and now they can't figure out what to do about it.
This isn't something easily fixed by swapping personnel or parties. With negative long-dated swap spreads there, plus bull steepening on the German curve, markets are far from sanguine about the prospects to turn everything around. For one thing, the economy is globally synchronized, which means the entire world is heading into a downturn, regardless of one country or another. More to the point, the cyclical aspects of the economy are lining up in just the wrong way, which means that even if there was some honest effort to try to turn it around, it's already too late.
At the very least, the vibe session strikes again. Any political regime which had fallen for the term is now paying the price. The last people you want to listen to on the economy are economists, and voters know it. Now they’re voting accordingly, and if they haven't already voted accordingly, like they haven’t in Germany, they will very shortly. Politicians are finally starting to wise up to this.
Here's what Bloomberg said: "Germany's ruling coalition collapsed on Wednesday, the same day Donald Trump was reelected in the United States, and the upheaval in Berlin could not have come at a more tumultuous time." The disagreements between the Prime Minister and the Finance Minister really boil down to, as I said, the economy. German Prime Minister Olaf Scholz sacked his Finance Minister Christian Lindner, forcing the governing coalition partners to pull out and triggering a confidence vote, which Scholz knows he’s going to lose. This will then trigger national elections around March.
Now, Scholz just wants to respond to economic weakness with the more traditional deficit spending type of stimulus package. Finance Minister Lindner is more of a deficit hawk, which is more common in Germany than in other places like the United States. There’s mudslinging back and forth, each one accusing the other of various things.
Scholz said Lindner has broken his trust too many times, describing him as "petty and selfish." Lindner fired back, saying that Scholz doesn't have the strength to give Germany a "fresh start," which Germany badly needs. He said that Scholz's plans were flat, unambitious, and contribute nothing to overcoming the fundamental lack of growth in our country.
None of this sounds like the booming economy that economists, policymakers, and politicians have been saying all along. Remember, it was back in January of 2023 when Prime Minister Olaf Scholz famously promised, "Germany will not fall into recession." What he said was, "I'm absolutely convinced that this will not happen," while Germany was already in one as he spoke those words.
Most importantly, Germany has yet to come out of it, the same for Europe, and a lot of other places around the world too. They’ve been selling this idea that it’s just a soft patch, a little bit of weakness—no big deal. Everything will turn around and skyrocket at some point in the future; we just need the right mix of whatever it is that we’re doing currently. We just need a bunch of patience. All you people need to stop whining about this vibe session.
Instead, what's really been happening is they've covered up substantial weakness, real recession-type of weakness because it doesn't fit their narrative or their agenda. We keep seeing this all over the world. They’d say it's a booming economy, but when given the chance, voters choose quite a different interpretation. They keep saying the economy is great and terrific; it's only a vibe session.
Then governments fall, and incumbencies erode. Again, it doesn’t matter what side of the aisle or the purported aisle that you think you’re on or you think that whatever government’s on; the German government is falling. In the United States, Trump beats Biden. In the UK, so-called conservatives were thrown out after more than a decade in power. Voters are just fed up, and they're taking that anger out on whoever happens to be in office at the current moment.
So stop calling it a vibe session and start realizing the economy sucks. It never recovered from the pandemic, and worst of all, it's showing more and more cyclical signs of getting worse. Consumers, voters, and businesses lost a ton of purchasing power a couple of years ago, and they know they're not going to get it back, especially if this cyclical downturn continues to develop, which closes off any hope of clawing back some of that lost power.
Even this description of what just happened in Germany fits more than just Germany; it fits with everything that we're seeing around the world this year. Germans are fed up with a coalition unable to make decisions as gloomy economic news is a near-daily occurrence. The German car giant Volkswagen is set to close three factories in its home country for the first time in its history, and BMW just announced that its profit margin fell to the lowest in more than four years.
That's exactly what I keep warning everyone about: the nominal illusion. The price illusion is wearing off, and as the nominal illusion wears off, what's going to happen? Businesses are going to respond predictably to the loss of margins and loss of revenue. They're going to start looking at what they actually produce, and nowhere is that difference greater than in the car business.
The car business looked like it was booming in 2021 and 2022 because of supply shock prices; revenue soared ahead, even though they were selling fewer units. They thought, well, prices will calm down and we'll eventually sell more units because the economy is recovering. That’s what everybody keeps telling us—that’s what economists and central bankers have been saying.
Instead, Europe and Germany fell into recession. They don’t sell more units, and now not only are they not selling more units, but prices are starting to go down. So now that they're selling fewer units than they thought, and prices are going down, there's no nominal cushion. Suddenly, without the nominal cushion, all of the companies—not just in the auto industry, but around the world—look at their workforce; they look at what they're actually producing and selling and what services they're providing, and they’re thinking, we’ve got too many workers, we’ve got too many facilities.
That’s the cyclical downturn that we're now seeing. We see it most clearly in places like Germany and industries like autos. While the media can downplay it, and politicians have been able to do so, the markets continue to warn: this is not a short-run phenomenon, nor is it looking like it's going to get better. They keep telling us it's going to get worse.
As I mentioned in the introduction and in yesterday's video about negative swap spreads—record negative swap spreads in the United States—a key cyclical warning about everything else there. German swap spreads just turned negative for the first time in history. And of course, the media sells it as, well, this is the marketplace suddenly afraid of Germany issuing too much debt. They always turn to too much treasuries. Never listen to economists on the economy; definitely don’t listen to economists in the media when it comes to interest rates and finance. They have no idea what's going on.
Here's a perfect example: swap spreads are a warning about the future of interest rates, not the future of debt, and the interest rates are going lower, not higher. They don’t even know which direction these things are telling us.
As the German negative swap spread is the same thing as a US negative swap spread, but now according to the mainstream media, they look at the swap spread and say this must be about Germany's deficit. I’ll give you an example: here’s Bloomberg just today, as the swap spread turned negative, a widely watched gauge of angst about bond supply.
It's not with the German 10-year yield climbing above the equivalent swap rate for the first time on record in another sign of growing fiscal concerns. The premium on 30-year debt over 2-year notes advanced again, lifting the spread close to its highest in more than two years. That's just bull steepening. That's not the market talking about and worrying about deficits; that's the market saying the economy is in bigger and bigger trouble. The negative swap spread, which is not about debts at all, is about interest rates and the directions of them.
Here the article refutes its own premise. After talking about how the collapse of the coalition triggered a sell-off in the bond market, they’re saying it helped fuel the sell-off in debt, despite opinion polls suggesting fiscal conservatism might remain under a new government. The center-right alliance under opposition leader Friedrich Merz is seen leading. Its stances include fierce opposition to additional joint European Union debt and supporting stricter rules on new borrowing.
So, they get rid of the current government and replace it with an even more fiscally restrained government. That's not fears of debt. The bond market is selling off because the bull steepening process continues to unfold. And this is how it unfolds. I’ll go over that in just a moment, but back to the swap spreads. Swap spreads have nothing to do with the fiscal situation of whichever government is issuing the debt; it's all about market hedging and fears of what happens in the real economy and the monetary system.
Here in Bloomberg’s own chart from the same article, you can see what looks very familiar when you compare it to US dollar swap spreads, which I discussed just yesterday. The swap spread chart from 2008 into 2009—a period of obvious bad economics and bad finance—shows bad money in Europe as well as everywhere else. What happens to the swap spread? It goes from highly positive to nearly zero under 20 basis points.
In fact, in Germany, that's a very low swap spread; that's highly concerning. Then what happens in 2009 and 2010 to 2011? The economy reflates. It didn’t actually recover, but it starts to move out from under the great not-recession—at least it’s reflating. The eurodollar crisis erupts, a banking crisis happens in Europe, and there’s a recession in Europe. Heading into that recession, the German swap spread collapses all over again.
In 2012, it finally bottoms out in 2014 as Europe and Germany begin to climb out, at least partially, from those dual recessions in the early 2010s. That's one reason why Europe sat out eurodollar number three, and you can see that in the German swap spread, which continues to get more positive through the latter half of the 2010s, up until 2018. Then, globally synchronized, suddenly, as the global economy and the European economy begin to fall off again into recession—pre-pandemic recession—what happens to swap spreads?
It's not about the German government suddenly becoming more fiscally reckless; swap spreads start to compress all over again because economic fortunes are diminishing. Then, after the pandemic—2021 into early 2022—swap spreads begin to decompress all over again, soaring higher, only to turn around in late 2022 when Germany falls into recession. And as Germany gets stuck into recession, look at what happens to German swap spreads—they get lower and lower and lower.
As they get closer to zero, that means the market is more and more confident that Germany's not going to get out of recession, that there are more cyclical forces guiding it further into one than not. This is not about debts and deficits; it's about economics and finance, which economists, the media, and central banks know nothing about.
This is not about deficits; it's not about debt; it's about interest rates and the direction of the real economy. As that crazy guy once said, "It’s the economy, stupid," and the financial risks that come with it. That's what the swap market is pricing. We see that in the German curve, which is also bull steepening. That’s not a market repricing of inflation and economic risk more favorably; it is the bond market coming to grips with the cyclical change that we observe all around the world.
We see bull steepening, as I mentioned in a video on Monday in US treasuries as well. Therefore, the media is selling the bond sell-off as deficits and inflation when swaps and the bull steepening are showing worsening conditions. You see that in the German curve, which, even though rates are rising in Germany as they are in the United States, that’s just the fluctuation of the marketplace—a part of the uncertain process of bull steepening.
So these are not positive signs, even if rates are nominally rising at this moment in time. They are rising within the bull steepening trend, just like US treasuries are doing here. You can see this difference: the illusion in real GDP in Germany—real GDP just came out last week. So rather than being negative, as was expected, German third quarter GDP comes in at plus 0.18%.
But there's no real difference there; that followed the second quarter GDP rate, which quarter over quarter was minus 0.29%. Interestingly enough, you look at Germany's GDP for the last 10 quarters—two and a half years—it has alternated between positive and negative: one quarter down, the next quarter up, the next quarter down, and up, back and forth the entire time.
So they get to avoid saying technical recession, but it doesn't actually matter. Even though Germany's economy doesn't have two straight quarters or more in a row of negative GDP, nor is there a big single downturn in any single quarter, it adds up to a huge recession anyway. The biggest thing here is time. You focus on the quarterly changes and the ups and downs in various GDP rates on a short-run basis.
Going back to the third quarter of 2022—when first of all swaps started to turn really, and swaps in Germany started to really compress and inversions in the yield curve went absolutely crazy—at the same time, Germany fell into recession. Compared to the third quarter of 2022, GDP in the third quarter of 2024, two years later, is only 610 billion EUR lower, which doesn’t sound that bad. It sounds like a vibe session, but you're not comparing GDP today with what it was two years ago—that's not the right comparison.
You need to compare GDP today to where it should be. If there was actually a recession, if the economy fell off and then recovered—that's what recovery actually means. It means recovering the prior trend. So where GDP is supposed to be—what we should be comparing it to—is if that trend had been unbroken. GDP in the third quarter of 2024 really should have been 790 billion EUR, not what it was.
It's more than 3% off of its 2020s trend; compared to the mid-2010s trend, it was more than 7% behind that one. So GDP actually understates the degree of contraction that the German economy is suffering, and that's what voters feel and can sense. The statistics don't look all that bad by themselves, but when you factor in time and what recessions are supposed to be, it is much worse than anyone is willing to give it credit for.
But it explains everything. Germany, like the rest of the world, keeps getting further and further behind, and people don’t like being left behind. Even though they can't see it in the quantitative numbers that come out across the media, they know—they can feel, they can sense—they are being left behind. So who can blame them for deciding to throw the bums out and give the new set of bums a chance to at least try to change things and turn everything around?
This is all a choice. Do you keep listening to economists or politicians who listen to economists who have been calling this a vibe session and ridiculing anyone who dares say it's anything other than a robust economy? After enough time, everyone gets fed up, or enough people get fed up that they start making changes. We've seen that all around the world.
I mentioned the UK; we saw it here in the United States, and it's about to happen in Germany after already happening in France. Japan is another one. Everywhere around the world, voters are fed up with being fed up, and they're fed up because the economy never actually recovered from 2020. It never recovered from 2008 either, but getting worse yet again, starting another decade, is becoming a bridge too far.
It's too much to ask anyone to just sit there and grin and bear it. There are very real consequences to the pandemic years still in front of us; that's what markets are saying, that’s what voters can sense. Who can blame them for trying to find someone to admit it and then do something about it? Negative swap spreads in the US, negative swap spreads in Germany—both of those are consistent with what the IA just reported: a decline in demand for gas soil.
I talked about that and how that's a critical signal in the video linked below. So always, thank you very much for joining me. Huge thank you to your University members and subscribers, and until next time, take care.