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The next Euro crisis could be made in Germany

Published on Newsroom.co.nz (Wellington), 19 August 2019

When Germany’s statistics office released the economic growth rate for the second quarter, the disappointing 0.1 percent decline added to the troubles on Wall St.

Little wonder stock markets are looking anxiously at Germany: the German economy remains the largest in Europe and the fourth largest in the world (behind only the United States, China and Japan).

Just for a sense of proportion, at a little more than US$4 trillion output, Germany’s economy is about 40 percent larger than France’s or the UK’s, twice the size of Italy’s – and about 20 times the size of New Zealand’s GDP.

Because of its sheer size, the fear of Germany falling into a recession must be a deep concern for Europe. Though Germany is not Greece, there are good reasons why the next Euro crisis could be one made in Germany.

By conventional definition, a recession requires two consecutive quarters of negative economic growth. Germany is not quite there yet. However, real GDP has effectively stagnated since early 2018.

The German public, meanwhile, has taken little notice of this. The unemployment rate is still hovering around the 5 percent mark, which is much lower than rates recorded at the beginning of the century when it peaked at 11.7 percent in 2005.

Since 2014, the federal government has also run budget surpluses and is planning another one for 2020. Again, this is a much-improved situation compared to the early 2000s when Germany violated the 3 percent deficit criterion set out in the European Union’s Maastricht Treaty.

Thanks to such positive figures on unemployment and debt, the Germans felt good about their economy, consumed and invested. Again, this is a marked change because, for many years, the domestic economy was Germany’s weak spot.

But now Germany’s export sector is showing signs of weakness.

To be sure, Germany is still running a giant export surplus. Last year, the country exported Euro 227 billion more goods and services than it imported. Due to the escalating tensions around global trade, it is a surplus which has now started to shrink fast.

As Warren Buffett famously put it, “only when the tide goes out do you discover who’s been swimming naked.”

For the export-dependent Germans, the latest trade figures would have been a rude awakening. Exports in June were a full 8 percent lower than they were in the same month last year. This is not just a small statistical fluctuation but a clear indication that something structural is happening. The sectoral data suggest this, too. Car exports were down 14 percent, and machinery exports fell by almost 7 percent.

Some factors contributing to Germany’s economic slowdown are external. The confrontation between the Trump administration and China is beyond anyone’s control. Similarly, the escalation in the Gulf and the uncertainty around Brexit affect trade. A trade-dependent country like Germany would feel these developments more directly than others without being able to do much about them.

Still, domestic issues are a cause for concern. As Warren Buffett famously put it, “only when the tide goes out do you discover who’s been swimming naked.” The global economic slowdown reveals Germany’s weaknesses.

Entire industries are going through painful reconfigurations in Germany. First among them is the car industry. Carmakers such as Volkswagen had systematically deceived regulators and the public about their products’ emissions. This led not only to substantial fines. It also caused slow-downs in production since cars needed to be re-engineered and certified.

The slow reorientation towards alternative fuels and engines puts German carmakers at another competitive disadvantage. EU moves towards stricter fleet emission standards exacerbate the challenge. Other countries producing smaller cars may find it easier than the Germans with their focus on the luxury end of the car market.

Then there is the German banking industry looking anxiously at a future of negative interest rates. If the European Central Bank goes ahead and moves the Eurozone deeper into negative territory, it will render many banks’ business models obsolete.

The situation is not made any better by the ongoing troubles at Deutsche Bank, which has just announced the closure of its global investment banking business and 18,000 job losses.

We could also look at the state of Germany’s internet infrastructure. Despite much talk from the federal government about digitalisation, Germany’s network connections are not fit for purpose. In Ookla’s global comparison of internet speeds, Germany ranks in 42nd place behind Montenegro, Moldova and Bosnia for mobile connections. For fixed broadband, it is a little better: It is in 34th place behind countries like Thailand, Malta and Panama.

To add to Germany’s woes, there is political instability. Both former ‘people’s parties’, the Christian Democrats and the Social Democrats, have shed much of their previous support. In their place, more radical parties on the left and the right, as well as the Greens, are dominating the political agenda.

This has created a culture of political uncertainty, activism and polarisation which Germany has barely experienced before. A case in point is energy policy where Chancellor Merkel recently announced to make Germany ‘climate neutral’ by 2050. It was a move meant to curb the rise of the Greens, but no-one can tell how such a policy could be achieved.

The only certainty is that it will be an expensive undertaking. Some industry experts like Fritz Vahrenholt, a former environment minister in the state of Hamburg, believe it could cost up to Euro 7.6 trillion – roughly twice Germany’s annual economic output.

Thus, Germany finds itself stumbling into a recession which is not entirely of its own making but for which it is altogether unprepared. And being the economic heavyweight of the continent, it will be Europe and the Eurozone strongly feeling the coming German recession.

Unlike the previous Euro crisis, which was a crisis of smaller Eurozone economies like Greece, a deep and structural recession in Germany is a different kettle of fish.

With interest rates as low as they are in Europe, there are limits to monetary stimulation. With debt rules in the EU Treaty and the German constitution, there are limits to fiscal stimulus, too. And with Berlin’s scene increasingly in a stalemate between weakened traditional parties, there is not much hope for political leadership either.

At the beginning of the century, The Economist famously called Germany the “sick man of Europe”. The way things are going, we are likely to read similar headlines again soon.

There is no obvious solution to the German crisis in sight.

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