What is the secret to Germany’s economic success, part 2?
Data out today show that German economic growth slowed sharply in the last quarter, with the economy growing at a weak 0.1% rate in the April-June quarter. Growth in the previous quarter was also revised down. to 1.3% from 1.5%.
Moreover while the euro zone-wide slowdown was not as severe, the data do show growth slowing from 0.8% in Q1 to 0.2% in the latest quarter. In essence, the euro zone economy is at stall speed and on the verge of recession.
Let me say a few words about Germany’s economic success in light of the latest data.
First, whenever I write a post, I like to look into my archives and see what I have said about the topic in the past. That usually means I end up linking to and quoting those posts as a mental note for myself, but also as a quality check. It’s easy to say one thing due to the exigent circumstances of the times and then flip-flop to saying something else three months later. my links serve as my way of avoiding this.
When I checked in the archives, here’s what I found first:
The bottom line: the fundamentals of the German economy are relatively good and support continued long-term growth.
Nevertheless, I am sceptical of the pace of German recovery for two reasons. First, Germany is fully integrated with the rest of Europe where many economies are struggling with debt issues, weakening demand for German exports…
Second, domestic demand remains weak in Germany. …German retail sales increased 1.2% in 2010… That this weak 1.2% increase in 2010 is the highest reading since 2005 and cause for optimism tells you that domestic demand growth is a sticky wicket for the German economy. Demographic factors almost certainly come into play here… [Claus Vistesen’s] post on an aging… points to an increasing burden from Germany’s social programs for pensioners. And German national debt of over 77% of GDP reflects this burden.
These headwinds point to moderating growth. And if the European periphery spirals down, it will drag Germany down with it via trade and financial linkages. Germany needs to develop internal demand, especially if it is going to pay for its social programs…
Overall, we should credit Germany for building a recovery based not just on exports, but on capital investment and saving. One reason that Germany is a manufacturing and export powerhouse is because it has invested in those businesses… And that is definitely worthy of emulation.
I stole the title from that post because I want to expand on it here. Germany has a large internal domestic economy that insulates it from exogenous shocks much as America’s large economy does. However, this effect only goes so far. So, this time, rather than extol Germany for the virtues of its economic success I want to talk more at length about the growth problems there.
First, Notice that a decline in household spending was a major contributor to the fall in Germany’s growth. Germany is aging. And that speaks to declining consumption demand and declining growth – just as it does in Italy and Japan, two other advanced economies mired in near zero growth with similar demographics. This is what is killing those highly indebted nations.
Look at the chart below and you can see the slowing growth.
Germany is trade-dependent
Moreover, there is also the trade connection. Germany’s export machinery creates a lot of economic volatility. That’s why German’s lead export group is pushing for Eurobonds. As I put it when the sovereign debt crisis was first beginning, Spain’s debt woes and Germany’s intransigence lead to double dip.
If Spain is forced to run austerity measures as seems likely, in stage two, this shifts their government deficit markedly down. Given Spain’s poor labour competitiveness, sticky wage prices and inability to depreciate the currency, all of the adjustment falls onto the private sector in the form of reduced net savings (which could include larger debt burdens). But, the thing to realize is that total GDP in Spain is lower in this scenario, which means total imports are lower, which means Germany’s total export volume is lower. This is a deflationary scenario.
And I use Spain here as a metaphor for the entire periphery. The euro zone is on the verge of a double dip, especially in view of the contractionary fiscal policies in the periphery. There is zero chance Germany can escape this unscathed.
Germany’s banks are under-capitalised
Everyone knows the peripheral bailouts are about German and French banks. The European banks were undercapitalised before the crisis and are still undercapitalised today. The real problem for the Germans is the recklessness of their banking sector. We saw the bailouts of Commerzbank, IKB and WestLB, HSH Nordbanken, and so on. The Irish debacle is about bankers gone wild in Ireland AND Germany. I should also point out how reckless German banks like Hypo Real Estate have been implicated in misadventures in Spain. And just to reinforce how wild German banks went, we have to remember that even Deutsche Bank, the biggest and most well-respected German bank, was getting hand outs from the U.S Federal Reserve to prevent its insolvency during the liquidity crisis in 2008-2009. In terms of economic weakness, this may be less relevant. But in terms of potential sovereign defaults or a banking crisis it is very relevant.
Germany does have a high debt load
I think this graphic from Die Welt makes that clear. Germany’s fiscal record is significantly worse than Spain’s over the last decade before the credit crisis such that it still has a higher debt-to-GDP ratio even today.
My point: There are a lot of reasons Germany has been doing well: wage restraint, educated workforce, low unemployment, etc. I could go on and on. But in a global growth slowdown, the Germans will not be immune any more this go round than they were last time when their contracted more violently than most along with the other export-dependent aging society, Japan. Austerity in the west, debt overhangs in the periphery and monetary tightening in emerging markets will act to slow demand globally. And this will certainly impact Germany.
If Germany wants continued economic success, its government must do a much better job in leading the euro zone out of its existential crisis. If the periphery sinks, we all sink.