The Weekly Echo (18/02/2025)

Welcome back to The Weekly Echo!

As we move further into February, the global economy continues to shift in unexpected ways. Stock markets are rallying, governments are making bold policy moves, and industries are adapting to new challenges. This week, we’re covering everything from Europe’s market highs and Japan’s surprising economic growth to Germany’s struggles, U.S. AI investment debates, and the Pentagon’s latest cost-cutting plans. A lot is happening, so let’s break it all down.

1. European Stocks Hit Record Highs Amid Defense Sector Surge

European stock markets are on a historic run, with the STOXX 600 index reaching an all-time high of 555.42. The rally has been driven largely by defence and aerospace stocks, which have surged 4% to lifetime peaks, having more than doubled in value since Russia’s invasion of Ukraine.

Why Are Stocks Rising?

Investor sentiment has been boosted by expectations of increased military spending, following the U.S.'s sudden reversal on Ukraine peace talks last week. Washington’s decision to cancel negotiations in Kyiv has strengthened the belief that Western nations will continue ramping up defence budgets, leading to a surge in demand for military equipment. 

The Defence Boom

• Defence stocks are attracting major investment, as governments worldwide increase their military budgets amid geopolitical instability.

• BAE Systems, a key player in defence and a FTSE 100 constituent, saw its shares jump 7.7% in late trading.

• European defence firms have doubled in value since the Ukraine war began, with sustained demand pushing valuations higher.

What This Means for You

• For investors, the defence sector remains a hot commodity, with rising global tensions fueling continued stock price momentum.

• For policymakers, the surge in military spending signals shifting economic priorities, with more public funds being directed toward defence rather than other sectors.

• For the broader economy, increased defence investment could stimulate growth in aerospace, manufacturing, and supply chains, though it may also lead to higher government debt levels.

With ongoing geopolitical uncertainty, markets are pricing in long-term demand for defence and security industries. The key question now is: Will this rally continue, or are we approaching a bubble in defence stocks?

2. Japan’s Economy Grows Faster Than Expected Amid Policy Shifts

Japan’s economy expanded at an annualised rate of 2.8% in Q4 2023, exceeding expectations and reinforcing its reputation as one of the world’s most resilient economies. Unlike the U.S. or China, Japan’s economic strategy is heavily shaped by demographic challenges, with an ageing population and a shrinking workforce, Japan is often considered a leading case study in navigating economic growth with a declining population.

What’s Driving the Growth?

• Business investment surged, with companies increasing spending on technology and automation to compensate for labour shortages, boosting productivity and economic output.

• Consumer spending picked up, driving demand and encouraging businesses to expand production. However, the sustainability of this trend remains in question due to stagnant wage growth.

• A weak yen boosted exports, making Japanese goods cheaper on the global market and improving the country’s trade performance.

A Historic Shift in Monetary Policy

Japan’s economic expansion comes at a critical moment, as the Bank of Japan (BoJ) makes its first major policy shift in decades. For years, Japan maintained negative real interest rates (where borrowing was cheaper than inflation) to stimulate investment and prevent economic stagnation.

However, with inflation rising and economic conditions shifting, the BoJ recently raised interest rates to 0.5%, marking the first hike since 2007. This move aims to curb inflation while preventing economic overheating, a delicate balancing act for policymakers.

Is Japan Escaping Stagflation?

For years, Japan was seen as the poster child for stagflation, a situation where slow economic growth, high inflation, and rising unemployment occur simultaneously. While Japan has struggled with low wage growth and weak domestic demand, the recent economic expansion and rising investment suggest a potential turnaround. However, inflationary pressures remain a concern, and policymakers will need to carefully manage rate hikes to avoid stifling the fragile recovery.

Japan’s Current Account Surplus Hits Record High

Japan recorded a current account surplus of 29.26 trillion yen ($193 billion) in 2024, a 29.5% increase from the previous year, making it the largest surplus since records began in 1985. Key drivers include:

• Record-high returns on foreign investments, strengthening Japan’s global financial position.

• A shrinking trade deficit, as exports surged due to the weak yen.

• Booming inbound tourism, with international visitors flocking to Japan, further boosting the economy.

What This Means for Japan and the Global Economy

Japan’s economic performance is being closely watched as a leading indicator of how advanced economies can grow with ageing populations. With record-breaking foreign investment, shifting monetary policy, and an evolving labour market, Japan faces a unique set of challenges:

• Balancing growth with inflation control - Raising rates too aggressively could slow expansion, while keeping them too low risks overheating the economy.

• Managing demographic headwinds - With a declining workforce, automation and productivity gains will be crucial for sustained growth.

• Global trade implications - Japan’s strong export performance could influence currency markets and global trade flows, particularly in Asia.

With a fragile but promising recovery underway, Japan’s next steps will be critical in shaping both its domestic economy and its role in the global financial system. The big question: Can Japan finally break free from stagflation, or will demographic and policy challenges pull it back into stagnation?

3. Germany Faces Economic Headwinds Amid Political Uncertainty

As Europe’s largest economy, Germany is facing mounting economic stagnation, with high energy costs, excessive bureaucracy, and a skilled labour shortage stifling growth. Over the past five years, GDP expansion has been sluggish, raising concerns about the country’s long-term competitiveness and industrial resilience.

Political Shifts Ahead of 2025 Elections

With Germany’s general election set for February 23, 2025, the economy has become a defining issue in political debates. Public frustration over rising costs, weak growth, and bureaucratic inefficiencies has led to a surge in support for alternative political parties promising economic reforms.

Policymakers are under growing pressure to stimulate investment, reduce red tape, and address labour shortages, all of which will be critical in determining Germany’s economic trajectory.

Industrial Heartlands Under Strain

Germany’s manufacturing hubs, traditionally the backbone of its economy, are feeling the strain:

• Cities like Gelsenkirchen, once thriving industrial centres, are struggling with rising unemployment and declining output.

• Energy-intensive industries, such as automotive and chemical manufacturing, are particularly vulnerable as high power costs eat into profit margins.

• The Mittelstand (Germany’s small and medium-sized businesses), often seen as the economy’s backbone, faces hiring challenges due to a skilled labour shortage.

What’s Next for Germany?

As economic policy and political dynamics collide, Germany’s next government will need to balance pro-business reforms with social protections while navigating global trade shifts and energy security concerns.

Can Germany revitalise its economic engine, or is it heading toward a prolonged period of stagnation? The decisions made in the coming months will shape not just Germany’s future but the broader stability of the European economy.

4. Pentagon Launches Cost-Cutting Initiative: Can the DOGE Team Deliver?

The U.S. Department of Defense (DoD) is preparing for significant budget adjustments as the Department of Government Efficiency (DOGE), led by Elon Musk, aims to reduce defence spending by 8% in the upcoming fiscal year. This initiative is part of a broader effort to address the $2 trillion federal deficit (excess spending over revenues).

Scope of the DOGE Initiative

While the defence budget is a primary focus, the DOGE team's mandate extends across various federal agencies. Key areas under review include:

• Weapons Acquisitions & Procurement: Evaluating and potentially reducing spending on defence contracts deemed excessive or redundant.

• Administrative Overhead: Identifying inefficiencies within bureaucratic structures to streamline operations.

• Climate & Sustainability Programs: Assessing the cost-effectiveness of green energy initiatives within the DoD.

• Agency Operations: The DOGE team has already made significant moves, such as dismantling agencies like USAID, leading to substantial civil servant dismissals.

Controversies and Legal Challenges

The aggressive approach of the DOGE team has sparked legal debates and concerns over the concentration of power. Experts warn that the rapid implementation of these measures, often bypassing traditional oversight, could undermine the rule of law and democratic principles.

What This Means for You

• Reallocation of Resources: Efficient defence budgeting could free up funds for other sectors like infrastructure, education, or technology.

• Impact on Employment: Reductions in defence contracts may affect jobs within the defence industry and related sectors.

• National Security Considerations: Balancing cost-cutting with maintaining robust defence capabilities is crucial, especially amid global geopolitical tensions.

As the DOGE team continues its review, the challenge lies in implementing meaningful reforms without compromising national security or democratic integrity. The coming months will reveal whether this ambitious initiative can achieve its fiscal goals while preserving the foundational principles of governance.

5. Is America’s AI Investment Strategy Falling Behind?

The United States continues to dominate global AI investment, but concerns are emerging about whether its approach truly maximises innovation and long-term competitiveness.

A Look at the Numbers

• Over the past five years, the U.S. has poured $328.5 billion into AI, with $67.9 billion allocated in 2023 alone.

• The bulk of this funding has gone to megacap (companies valued over $200Bn) tech companies like Microsoft, Alphabet, and Amazon, which are leading the charge in AI research, cloud infrastructure, and model development.

Is the U.S. Over-Reliant on Big Tech?

Some experts argue that funnelling the majority of AI investment into a handful of tech giants may limit true innovation. While these companies are advancing AI at an unprecedented scale, the focus on large-scale models and proprietary systems could slow the development of diverse, real-world applications.

Is the U.S. AI Investment Strategy Too Narrow?

While the U.S. remains the global leader in AI investment, concerns are mounting that its strategy may be too concentrated in a handful of tech giants, leaving other critical areas underfunded.

• Startups and industry-specific AI applications in sectors like healthcare, manufacturing, and finance may be missing out on funding, limiting the potential for breakthroughs outside of consumer tech and cloud services.

• Over-reliance on a few dominant players, even those with a strong track record, carries risks. History has shown that even the most successful tech giants can fall behind in the rapidly innovating sector. BlackBerry and Nokia once dominated mobile technology but failed to adapt, ultimately losing their competitive edge. Could today’s leaders face a similar fate?

• Regulatory scrutiny is rising, with concerns that a small number of firms could monopolise AI advancements, restricting competition and stifling broader technological progress.

• Global competition is intensifying, particularly in Asia, where governments are strategically funding AI development across multiple industries, not just within a select group of major firms.

Are AI Investment Estimates Overblown?

Another question now surfacing: Are current AI infrastructure investment estimates realistic?

• Much of the demand for AI hardware is based on assumptions about current capital requirements. However, recent developments such as China’s DeepSeek LLM, which was built at a fraction of the cost of U.S. counterparts, are challenging existing cost expectations.

• If AI development becomes more efficient and less hardware-intensive, current investment projections could be significantly overstated, raising questions about long-term sustainability in the AI race.

As the U.S. moves forward with its aggressive AI spending strategy, the real challenge will be ensuring that investment is distributed effectively, encouraging both large-scale innovation and the next wave of emerging AI disruptors.

What This Means for You

Suppose the U.S. continues prioritising big tech-driven AI investment. In that case, it risks falling behind in the long run, as smaller, more specialised companies may be the key to unlocking real-world, industry-transforming AI applications.

For investors, diversifying AI exposure beyond megacaps could prove beneficial, while policymakers may need to rethink AI funding strategies to ensure the U.S. remains at the forefront of AI innovation, rather than just the largest spender.

As global markets react to rising trade tensions, shifting monetary policies, and record-breaking investments, 2024 is already proving to be a pivotal year for the world economy. From Japan’s delicate balancing act to Trump’s escalating tariff war and Europe’s market volatility, the next few months will shape the economic landscape in ways we’re only beginning to understand.

At Echonomics, we’re committed to keeping you informed, breaking down the biggest stories, cutting through the noise, and making economics accessible.

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Thanks for reading, and see you next week!

Best wishes,
Harry & Reika
Co-Founders, Echonomics

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