Why canceling the "Panzerschiffe" in the first place is the question.
First:
This type of over armed commerce raiding cruiser was a political statement by the German State pre-NSDAP, pointing on the Versailles Treaty the German Naval Enginering and designing Ingenuity still existed, as at the same time pointing a middle finger to the former victors that had forced the Versailles treaty upon Germany in the first place. The main reason the "Panzerschiffe" had been developed were a direct result of the Versailles treaty Naval section. Having no such extreme cruisers designed would only have been possible with no Treaty of Versailles in the first place.
Second:
The Great War had already shown the Reichsmarine, its predecessor should put it attention not on a classical battlefleet, but at a navy designed to counter enemy (=British) commerce at sea, meaning: commerceraiding as a main goal, demanding ships designed to do such a role, both surface and subsurface. With the restrictions of the Treaty of Versailles, the designers put their skills into developing a design roughly within the limitations put on by the former Entente, though cheating a bit in details, like any nation did at this time, except the UK. (Yes USA also cheated partly in some cases = see Lexington class CV conversion) As a result of this the German Engineers and designers had a choice to either put to sea a more traditional sort of cruiser, that was inferior an every aspect to almost everything the opposition could bring out to sea, or design something spectacular to upset politics and make a statement. They choose the later for obvious reasons.
Third:
Hindsight is irrelevant as everything can be done better with hindsight. The timeframe the project was started was one where the German Navy legally had the right to replace a number of overage capital ships for the Reichsmarine, within the restrictions of the Treaty of Versailles, so they had to work with this knowledge no matter what else. The choices were:
1. Replacement by a coast defense battleship, which was the type the former Allies wanted the Germans to restrict themselves to. This was a pure defensive type, simmilar to the existing Pre-Dreadnoughts and Swedish Sverige class. Slow and decently protected with a short range, incapable of sailing the oceans. This was unacceptable for the Germans as it would mean they would accept the Treaty of Versailles as such, which they severely objected to in the first place.
2. Replacement by a traditional sort of long ranged cruiser, similar in concept to other cruisers abroad of similar size. This was not acceptable as well, since the German ships would be seen as replacement for a capital ship, rather than just a cruiser, therefor limiting the numbers allowed for in the Navy. In case of a conflict these small numbers would be a serious tactical problem as these ships were not considered to be capable of defending themselves against the already vastly superior numbers of expected opposing cruisers.
3. Replacement by a radical new design focused on commerceraiding, stronger than anything faster (apart from a very small number of British battlecruisers still in existence) and faster than anything stronger. This was the only realistic option at the time, other than deleting the navy as a whole. (Note submarines were still banned in this period.)