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Why Defence Spending Is about to Blow Up (Even More Than It Already Has)

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By Nick Hubble, Saturday, 18 February 2023

In response to a power vacuum left by President Biden, and a shortage of equipment and ammunition caused by the war in Ukraine, the world is increasing its defence spending, dramatically. But the boom is only just beginning.

Defence spending around the world is booming. You could even call it a rearmament. Today, we dig into why this trend began, and why it’s still being underestimated by financial markets. Then, I’ll give you a cookie for guessing what investors should do about it…

For decades, Pax Americana meant that a long list of nations didn’t need to maintain defence spending at a respectable level. Specifically, the nations I’ve lived in have benefitted the most from this.

On the one hand, I grew up keenly aware of why pacificism is a good idea. While also being aware of the hypocrisy of living under the US’s protection the whole time. I even went to school with the children of American soldiers stationed in Germany.

But Pax Americana started to slowly crumble over the past few years. First President Trump called out his allies for their financially unfair lack of defence spending — a violation of NATO commitments. And then he demanded his allies spend double those NATO commitments — 4% of GDP instead of 2%!

Of course, these concerns were nothing more than the rantings of a deranged lunatic…until Trump’s other warnings came true. Europe’s reliance on Russian energy turned out to be no laughing matter after all.

In fact, once you put the invasion of Crimea, Georgia, and Ukraine on a timeline, it’s worth noting that Russia has been busily invading Eastern Europe for quite a long time now. With only a brief lull that coincided with the term in office of a certain US president…

But let’s not get too supportive of any politician.

President Biden, on the other hand, pulled out of Afghanistan in disastrous fashion and made several gaffes, such as declaring a minor incursion wouldn’t amount to an invasion of Ukraine.

Worst of all, the US used the US dollar as a weapon against Russia. This means that international trade is now a strategic war zone too. And nations who don’t want to take sides in that battle need to be able to do business with whomever the Americans try to sideline economically. Japan is still busy buying Russian oil and gas, for example.

The point is, the US demanded the rest of the world defend itself, and then gave them damn good reason to be able to.

Just as nature abhors a vacuum, war is always waiting to fill a lack of defence spending. And so, Europe has responded.

In September, the European Commission estimated that since the war in Ukraine began, EU governments had pledged extra defence spending of about 200 billion euros.

A great deal of this is to replenish stockpiles sent to Ukraine, which is currently using more ammunition than Europe can produce. Another chunk is assigned to the modernisation of outdated militaries. And a third category is aimed at helping European defence manufacturers capture the bulk of the revenue flow in the name of supply chain security and onshoring.

One of the key issues is that in order to increase production capacity to meet demand from Ukraine, let alone an expansion of European defence forces, manufacturers need to make large investments in production. This, in turn, requires long-term orders to justify, not just a brief war in Ukraine.

So, in terms of capacity, Europe is at a crossroads. It can ramp up the defence industry and defence spending, or it can continue to use broomstick handles as guns while Ukraine chews through their ammunition stockpiles.

They’ve chosen to expand spending and production. Let’s look at some examples…

The previous German defence minister revealed a lack of ammunition in the German military before losing her job. The new defence minister has declared the defence budget and a special defence fund of 100 billion euros, twice the size of the regular budget, to be insufficient to overhaul the military.

Consider this extraordinary U-turn, which really is a sign of the times, as reported by Bloomberg:

‘Germany is considering re-routing existing subsidies for eliminating coal-fired power plants to help defense manufacturers build new production facilities, according to people familiar with the matter.’

When rearming Germany to defend against Russia is more important than saving the planet, you know the world has changed…

French President Macron has proposed a vast military spending increase of about 40%, on course for a doubling since he was elected in 2017.

Spain’s 2023 budget includes the largest increase in military spending in its history, a 26% jump. Which is technically still well short of NATO commitments, but there are additional funds assigned to modernisation programs awarded to Spanish companies.

According to the Delàs Center for Peace Studies, once you include such programs, Madrid’s real military spending will be 27 billion euros, or 75.7 million euros per day. This means Spain will already exceed NATO’s spending target by 2023, and ‘for every ten euros that the state invests in 2023, three will be for weapons’.

Former UK Prime Minister Liz Truss had committed to doubling UK defence spending by 2030, but the new government is more reluctant to increase spending so far.

Outside of Europe, the trend continues, but in even more dramatic fashion.

The biggest player is, of course, the US. Congress approved a defence budget US$45 billion larger than sought by President Biden, an 8% increase, including a 55% jump in Army funding to buy new missiles, and a 47% jump for the Navy’s weapons purchases.

A trillion-dollar defence budget is in sight, with the latest package only US$150 billion short. More than half this amount flows through to US defence companies, with the ‘big five’ collecting between US$150 and US$200 billion. The increase in US defence spending for 2023 matches the military budget of nations other than China.

The New York Times provides some context for the US situation:

‘Military spending next year is on track to reach its highest level in inflation-adjusted terms since the peaks in the costs of the Iraq and Afghanistan wars between 2008 and 2011, and the second highest in inflation-adjusted terms since World War II — a level that is more than the budgets for the next 10 largest cabinet agencies combined.’

Outside the US, perhaps most intriguing of all is Japan’s plans to rearm. The aim is to double defence spending from 1% of GDP — a US$320 billion jump, which amounts to the creation of the world’s third-largest defence force!

But India may not be content with being leapfrogged. A 13% increase in defence spending is included in their budget. The non-salary segment of spending will increase 44%.

The point is that the world’s getting ready to defend itself independently of the US as guarantor. They’re supporting long-term changes to defence manufacturing capacity, not just replenishing resources used by Ukraine.

All this also comes with a lot more risk of conflicts breaking out. Young people of the world are going to be dumping their dual citizenships faster than Australian politicians in 2018.

It also suggests severe budget cuts on the butter side of the equation. Governments cannot afford both defence spending and welfare at current debt levels.

Of course, the course of action for investors is fairly obvious. Australian investors should be soaking up defence stocks. And hoping we avoid a third world war…

Until next time,

Nick Hubble Signature

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend

PS: You can get my specific strategy for defence stock exposure in a unique Australian chapter I wrote for Jim Rickards’ new book, SOLD OUT!. This chapter is only available as part of our ‘Preparation Package’. Find out more here.

All advice is general advice and has not taken into account your personal circumstances.

Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

Nick Hubble

Nick Hubble found us at Fat Tail Investment Research in 2010 after a stint inside Wall Street’s most notorious bank, Goldman Sachs, during the 2008 GFC. That’s where he saw the true nature of the investment banking business. Since then, he’s been the editor of the Daily Reckoning Australia and the UK-based Fortune & Freedom and Gold Stock Fortunes.

He’s delighted to work as Investment Director and Editor for Jim Rickards’ Strategic Intelligence Australia. Here he helps turn Jim’s big-picture views into specific actionable advice and ideas for Australian investors.

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All advice is general in nature and has not taken into account your personal circumstances. Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment.

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