The flagging German economy
Germany is a very open economy given its size, with exports at 45.6% of GDP compared to less than 14% for the United States. This makes Germany more vulnerable than most to the global growth slowdown, especially given its recent turn to non-EU trade to fill in for weak domestic demand growth. Recent numbers out of Germany suggest economic slowing, with the capex implications from the VW scandal likely adding to the slowing.
If we rewind to reunification and the excesses from that period, Germany lapsed into a soft depression in the period leading up to the euros formation. And the reforms Germany made to become competitive were prompted by the large trade volume the country does, making its GDP growth dependent on its productivity and wage competitiveness. Most of the German reforms revolved around measures that controlled labour compensation such that by the time the financial crisis hit German exports were competitive in terms of a price-quality trade-off.
As Germany reformed, the periphery boomed. And this helped Germany to overcome its domestic demand malaise through exports. Before the 2008 financial crisis, Germany was in what I called a vendor financing scheme with the eurozone periphery. German current account surpluses were mirrored by periphery deficits, which put Germany in a net creditor position vis-a-vis the periphery. But lending of this nature on a persistent basis leads to problems when debt levels increase and Germany felt the full bore of retrenchment and deleveraging in 2009, as its economy contracted the most in modern history as exports to the periphery dried up.
And though the weakness in the periphery impacted the German economy negatively early in the European sovereign debt crisis, German companies successfully pivoted to emerging markets as the periphery went into depression. And this has buoyed the German economy. Now, however, as the emerging markets have slowed, the German growth model is showing weakness.
German factory orders unexpectedly fell in September for the second month on the trot. And the recent weak export data confirm that the source of the problem is trade. German exports recorded their biggest slump since the financial crisis in September. At the same time, Germany is dealing with two other major issues in the refugee crisis and the VW scandal. It’s not clear to me that the scale of the refugee crisis is such that it will have country-wide GDP implications but the VW scandal will both in terms of car sales and in terms of capital expenditures. VW has said that going forward it will cut all capital expenditures that are not mandatory as it needs to husband cash to pay for the fallout from the defeat device fines and litigation it is likely to incur. This will have an immediate and widespread impact on the German economy.
The surprise writedown at Deutsche Bank does not necessarily have systemic economic consequences because they are a recognition of past losses. However, I believe the loss recognition and the need to raise capital is emblematic of the credit situation in Germany (and Europe) and suggests that credit conditions will continue to be weak domestically. The question now is whether the export weakness will be something persistent or whether it is an aberration. In July, German industrial production numbers were the strongest for all of 2015. And trade figures hit a record high. So I am not convinced yet that the last two months are a trend. But I do think Germany’s dependence on external demand makes it uniquely vulnerable . And I also believe that emerging market weakness will persist. Ultimately this weakness will translate into continued lowflation and bond strength.
Let’s remember that the global growth slowdown is not new, it has been an ongoing phenomenon for five years, despite the post-crisis global economic recovery. If you look at the IMF’s latest report, you will notice that 2015 will be the fifth consecutive year that growth rates in the emerging markets have slowed. Christine Lagarde said at the annual meeting in Peru this week:
“Global growth will likely be weaker this year than last, with only a modest acceleration expected in 2016.”
The good news is that we are seeing a modest pickup in advanced economies. The moderate recovery is strengthening in the euro area; Japan is returning to positive growth; and activity remains robust in the US and the UK as well.
The not-so-good news is that emerging economies are likely to see their fifth consecutive year of declining rates of growth.
India remains a bright spot. China is slowing down as it rebalances away from export-led growth. Countries such as Russia and Brazil are facing serious economic difficulties. Growth in Latin American countries, in general, continues to slow sharply. We are also seeing weaker activity in low-income countries – which will be increasingly affected by the worsening external environment.”
I first talked of a global growth slowdown in May of 2012 and have written headlines with that moniker a number of times since, according to my archive search. The question is what’s different now than in 2012, 2013 or 2014. I think the answer is how widespread the slowing is, and the degree to which China has slowed and commodity and oil prices have declined. All of these factors, unless reversed, will negatively impact a German export-oriented economy that is more reliant on China and other emerging markets than it was previously. And I do expect the slowdown to continue.