Germany's Economy: How Did They Get into This Mess?

Everything in Germany is going up, except it seems the real economy - and except of course prices, which were stationary in May (that is a change of 0% year on year - the lowest inflation rate for over 20 years). Anyway, today it was the turn of investor confidence to put in another good reading. In fact, German investor confidence rose to what is effectively a three-year high in June. Apparently, investors feel the recession in Europe’s largest economy is bottoming out.

The ZEW Center for European Economic Research said its index of investor and analyst expectations increased to 44.8 from 31.1 in May - the highest reading since May 2006.

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Unfortunately, there is little real evidence to support this highly optimistic view of the future.

True, German retail sales were also up in April - for the first time in four months - as warmer weather, falling prices and the late Easter holiday seem to have encouraged consumers to spend more. Seasonally adjusted rose 0.5 percent from March, according to the Federal Statistics Office. Nonetheless, year on year sales were still down 0.8 percent.

And in the longer run, German retail sales are declining steadily.

Indeed, according to the May retail sales PMI Germany posted the steepest fall in monthly sales among the "big three", replacing Italy poll position. The German PMI fell to 46.3, the twelfth successive month the measure has shown a negative reading. Interestingly, the PMI more or less accurately picked up the improved position in April.


Exports Still Stuck At A Very Low Level - And Falling

Both exports and investment spending plunged in Germany during the first quarter, dragging the economy down into its deepest economic slump on record.

Exports were down 9.7 percent from the fourth quarter of last year and company investment declined 7.9 percent, according to the detailed report from the Federal Statistics Office. The Office reported that GDP fell a seasonally adjusted 3.8 percent from the previous three months, confirming the initial estimate from May 15. That’s the largest drop since quarterly data were first compiled in 1970.


German exports have not touched bottom yet, and they are still falling, with seasonally and working day adjusted exports dropping 4.8 percent in April from March, when they rose a revised 0.3 percent. Since the German economy is completely export dependent, this implies the obvious, that the German economy is still contracting. I don't think anyone ever doubted this, but looking at the way the investor confidence reading is being presented today, you could be forgiven if you had gained the opposite impression.

Indeed on a year on year basis, exports were down by 22.9%, the fastest rate of decline registered so far, although since such annual stats are not working day corrected I wouldn't read too much into that just yet, since you really do need to average across March and April due to the Easter impact.


Both Trade And Investment Drive The Economy Downwards

Looked at between quarters, the German economy contracted by 2.2% (or at an 8.8% annualised rate) over the last three months of 2008, following a 0.5% drop in both the second and third quarters of last year.

According to the statistics office, the decline was mainly due to movements in the balance between exports and imports (goods and services combined). As in the fourth quarter of 2008, German exports fell much more than imports. The negative first quarter performance was also associated with a notable decline in investments (down 7.9%, quarter on quarter). Capital formation in machinery and equipment, in particular, was much lower. Companies invested 16.2% less in machinery, equipment and vehicles than in the last quarter of 2008.


Inventories were allowed to deplete during the quarter, which reduced growth by 0.5 percentage points. The only really positive elements were household and government consumption, which were up by 0.5% and 0.3% respectively.

In contrast to the bleak picture for investment, fixed capital formation and German exports, final consumption expenditure was ever so slightly up quarter on quarter - by 0.1% - and even did slightly better than in the last quarter of 2008 (– 0.0%).


On a year on year basis, household consumption was marginally down though - by 0.1% (following a 0.5% drop in the fourth quarter of 2008), general government consumption expenditure, however, was up by 0.8%.

The Long Term Outlook

The first-quarter GDP performance has thus completed an unprecedented four quarters of continuous contraction for the Germany economy. The German government has said it now expects the economy to contract by 6 percent over the year as a whole, and even optimist ECB council member Axel Weber has admitted that while he can see some positive “rays of light”, there’s still “no reliable indication that the global economy is past the worst.” The euro-region economy may only “gradually stabilize during the latter part of 2009.”

The longer term decline in German GDP performance is now pretty clear (see chart below).

According to the Federal Statistics Office:

Measured in terms of gross domestic product changes at 1995 prices, the rates of economic growth in the former territory of the Federal Republic of Germany and - since 1991 - in Germany have continuously declined since 1970. While the average annual change was 2.8% between 1970 and 1980, it amounted to 2.6% between 1980 and 1991 and to 1.5% between 1991 and 2001.

Since 2001, the performance of the German economy has in fact been worse rather than better, much to the consternation of those who hoped that many years of sacrifice in the form of wage deflation and structural reform would lead to a rebirth of the country's former economic prowess. In reality, the German economy shrank (0.2%) in 2003, and grew by only around 1% in both 2004 and 2005. And while the German economy picked up notably in 2006 and 2007 (with growth rates of 3.2% and 2.6% respectively), and many talking in terms of such grandiose notions as global uncoupling and "Goldilocks" type sustainable recoveries, the most striking feature of the recent German dynamic has been the way that internal demand failed to respond to the externally driven export stimulus. Of course, all the speculation came to an abrupt end in 2008 when the German economy once more entered recession as world trade expansion slowed and exports collapsed (with GDP only growing by 1% over the year), while 2009 looks set to be a lot worse (with the IMF currently forecasting a contraction somewhere in the region of 5%, and forecasts of up to minus 7% not seeming exaggerated).

What we seem to have here is "engine faliure" rather than mere "magneto problems" (using Claus Vistesen's memorable phrase for a very similar situation in the Japanese economy, and it would be nice if the current crisis could serve as the stimulus for an open, and "in the real world" debate about why this is. So some part of the traditional mechanism of economic transmission seems to have been broken, and the "second leg" of the economic cycle, the domestic consumtion driven one, seems no longer to work. Long term GDP growth rates in the German economy are clearly falling, and the decline looks clearly set to continue.

And as Will Hutton points out to Paul Krugman - on top of the massive drop in economic activity there is a huge potential banking crisis looming over the horizon. The IMF have warned that Germany could be looking at over $500bn of writedowns. German banks - according to Hutton - hold a trillion dollars - maybe more - of maturing collateralised debt obligations. And as Krugman says:

It’s Germany on a global scale that is the concern. We worry about the drag on world demand from the global savings coming out of east Asia and the Middle East, but within Europe there’s a European savings glut which is coming out of Germany. And it’s much bigger relative to the size of the economy.

So we know that the German economy (like its Swedish counterpart) is now by and large a very unstable cocktail of accumulating surpluses and using them to finance risky lending elsewhere. But why and how exactly has Germany gotten into this mess? On this there is largely silence. The falling and aging population issue couldn't have anything to do with it, now could it?

Comments

[Dave Wrixon:]

Americans are obviously not buying cars yet, then!

Jun 16 06:18 PM

[whidbey:]

The effects on the rest of the world are prime.

Germany the exporter was always the money machine to the EU. The trend today is toward a smaller, less stable, poorer Germany. The effect will be to weaken the EU as an economic block. Age? yes, but a worn out adherence to mercantilism is also involved. Deregulation would in loose a great deal of talent and innovation.

Jun 16 09:58 PM

[dybydx:]

the situation kinda look like japan, a stagnant econ. despite GDP per worker continue to rise, overall gdp is rather stagnant.

Jun 16 10:34 PM

[punk_ash:]

Germany makes the best product at very high prices, but China produces barely usable stuff for almost free, and most people are opting for Chinese stuff.

Who in their right mind will buy a German car in US when it costs 5 times as much to fix a Japanese or American car.

Germany's business model will have to adapt to the new world order.

They can count on their beer to sell since Chinese do not make beer.

Jun 17 02:18 AM

[Dave Wrixon:]

Rubbish. Like everywhere else Germany needs to push forward with more cutting edge products, but it is certainly not related to the extinct US Dodo.


On Jun 16 09:58 PM whidbey wrote:

> The effects on the rest of the world are prime.
>
> Germany the exporter was always the money machine to the EU. The
> trend today is toward a smaller, less stable, poorer Germany. The
> effect will be to weaken the EU as an economic block. Age? yes, but
> a worn out adherence to mercantilism is also involved. Deregulation
> would in loose a great deal of talent and innovation.

Jun 17 02:46 AM

[Dave Wrixon:]

There will obviously always be a market for quality products but Germany needs to turn its marketing efforts away from markets such as the US which are gearing for the lowest common denominator such as the US. German cars may be more expensive but at least they don't spend their life in the service garage. Personally, I still think the Japanese have the innovative edge. American cars are really only fit for keeping hens in.


On Jun 17 02:18 AM punk_ash wrote:

> Germany makes the best product at very high prices, but China produces
> barely usable stuff for almost free, and most people are opting for
> Chinese stuff.
>
> Who in their right mind will buy a German car in US when it costs
> 5 times as much to fix a Japanese or American car.
>
> Germany's business model will have to adapt to the new world order.
>
>
> They can count on their beer to sell since Chinese do not make beer.

Jun 17 02:50 AM

[jeremiah74:]

excellent article !!

Europe's problems could make it the next in line to suffer a crisis on confidence in European stock markets, currencies..etc
but i would still expect German Bunds to do well. no reason to doubt the creditworthiness of those. in fact a Euro crisis would probably benefit bunds as investors flee from the peripherals

Jun 17 08:50 AM

[Ferdinand E...:]

You forgot to mention the German energy policy, which is among the craziest in the world. But it isn't the German government that is responsible for this abomination, but German voters. They just don't get the message.

The funny thing about Germany, and Sweden of course, is that if the drowsy voters thought more about solving their own problems instead of those of stone age countries on the other side of the world, it might be a simple matter to put their economies in order. 'Might', because the question is whether anybody can do anything if the US economy falls apart.

Jun 17 09:41 AM

[jack kreg:]

you completely missed the point, EU socialism is the cause, and the EU voters are rapidly turning to center-right, in repudiation of socialism failure to position the EU for this century.
Sadly, the USA is trying the socialist shoe on, gladly the early signs are that the US voters will close the socialist book in the coming elections of 2010 and 2012, it is happening right now in CA where the budget socialist are being starved out of town and lavish gov spending is finally being cut to the bone as it should have been long ago.
It all about repudiation of socialist failures in EU.

Jun 17 11:39 AM

[Firat Ünlü:]

Following the Keynesian clown model proposed by the likes of Krugman Germans could always double government deficits (the German deficit is comparatively small) and spend all their 'excess' savings to bolster growth now. Someone should however have mentioned to those advocating for more and more spending that the German society is an ageing one and that in a world where capital is precious savings are any nations's treasure as only savings can finance investments. Whether GDP goes down or not Germany as a country looks stable (apart from the banking sector which is intransparent but that's the case anywhere) in the middle to long-run. It's main problem is that its schools churn out more and more people that can't keep up with global competition which is why I can see budget constrains arising quite soon as benefit spending will have to increase.

Jun 17 11:52 AM