Why Germany's Economic Fortress Could Come Toppling Down

Includes: ERO, EU, EWG
by: New Deal 2.0

By Marshall Auerback

If the fiscal austerity fad continues across Europe, Germany’s economy (ETF: EWG) — already feeling the impact — may tank.

It’s very courageous to write something contrary to the prevailing mainstream “conventional wisdom” (which is actually hysteria), but thankfully some people are beginning to recognize basic facts. One such voice is David Leonhardt of the NY Times, who has dared to challenge the prevailing narrative that “reckless government spending” is now endangering growth. Quite the contrary, as Leonhardt points out in the context of “fiscally responsible” Germany:

Well, it turns out the German boom didn’t last long. With its modest stimulus winding down, Germany’s growth slowed sharply late last year, and its economic output still has not recovered to its prerecession peak. Output in the United States — where the stimulus program has been bigger and longer lasting — has recovered. This country would now need to suffer through a double-dip recession for its gross domestic product to be in the same condition as Germany’s.

Of course, let’s not crack open too many bottles of champagne for the US, where unemployment is still a big deal and the current focus of economic policy is to eviscerate what is left of our social safety net. There is still a crying need for direct job creation schemes in the US to address our growth without jobs, and we’re moving in the opposite direction.

And, as Leonhardt’s article illustrates, it now appears that Germany’s comparative ability to insulate its unemployment from the output collapse (a product of the recent strong export sector and modest fiscal stimulus) is starting to erode. In fact, European economic data has begun to sour all across the continent, and not just in the periphery countries, such as Ireland, Portugal, Spain and Greece.

European fourth quarter GDP growth came in up 0.3%, non-annualized, a little less than expected. German growth, up .4%, and French growth up, .3%, were also a little less than expected. In Germany, all things building-related were very weak, suggesting the adverse weather contributed to the weakness. However, some signs of strength in Northern Europe, such as surprisingly positive Dutch and Finnish economic growth and strong French household spending, all despite unusually bad weather, make one wonder if something else was contributing to the weakness. Specifically, Germany’s industrial production fell by a very large 1.5% in December after a .6% decline in November. Maybe that is more than is warranted by adverse weather. December factory orders fell 3.4% in December.

Now, perhaps part of this is just a “give back” from the huge 5.2% rise in November. But how, then, does one explain the appalling retail data, which has failed to rise in response to last year’s very considerable surge in production? The signs of flagging consumer spending are quite widespread — in the core countries of Germany and France, no less. Although fourth quarter French household spending was apparently strong, the French consumer confidence index in January fell to 85 from 86 in December and 89 in November. In Germany, where the consumer confidence index had been soaring, it has now fallen in both December and January. More striking has been the German retail sales data, which has been very weak despite considerable strength in the indices for German consumer confidence and German retail business sentiment in the second half of last year.

My guess is that fiscal restriction to varying degrees across Europe is probably slowing the pace of European economic growth, which may be surfacing in some of the recent data. Fiscal austerity is the price the ECB is demanding in exchange for continuing to backstop the bond markets of the periphery countries, which are suffering from ongoing solvency crises. It will almost certainly continue, as the recent German election results (where the ruling party did very poorly) suggest that Chancellor Angela Merkel feels she will be forced to adopt a harsher stance on fiscal austerity to placate the voters at home, which may well make things worse.

I don’t think Germany will leave the eurozone (as many Germans are now demanding). But the weakness of its prevailing position is that they continue to see the structural problems inherent in the eurozone as symptomatic of lax fiscal policy or poor economic management on the part of the periphery countries. That’s NOT the problem. The EMU structures themselves are.

The current weakness in Europe suggests that even Germany is subject to these economic pressures, as fiscal austerity is beginning to destabilize the financial systems of the GIIPS countries and weaken overall European aggregate demand. Germany’s vulnerability has hitherto been masked somewhat by the comparatively strong position of its national finances to this point (although its banking system is still very vulnerable to additional shocks in other parts of the eurozone, due to the high holdings of euro-denominated national debt). The perception of Germany as an impregnable economic fortress could well change if the conditions of fiscal austerity intensify and the pressures move from the periphery to the core, as it appears they now are. Sharply rising oil prices are another new depressant, which could well affect consumer discretionary spending power as well.

For understandable historic reasons, Germany today has an irrationally high fear of Weimar-style inflation. This has precluded them from accepting more of a quasi-supra national fiscal entity of the sort that is required to fix this problem via more stimulatory fiscal policies.

At present, private spending in the eurozone and the UK is being cut back and pressures are building to do the same in the US as we approach D-Day with the debt ceiling. Politicians who fail to understand basic accounting 101 realities fail to understand that there is a huge private debt overhang to eliminate as a result of the out of control credit binge. (This was urged along by the very same people and ideas that are now posturing for austerity, as Bill Mitchell has repeatedly pointed out.)

There is a long way to go before the private sector will have adequately restructured their balance sheets so that they will be prepared to spend freely again. Unless some other sector is willing to reduce its net saving (such as the external sector via trade) or increase its deficit spending (as with the federal budget balance of late), then the mere attempt by the domestic private sector to net save out of income flows, given the existing private debt overhang, can prove very disruptive.

Would that our officials recognized this. Instead, we have the spectacle of governments across the world engaged in significant fiscal retrenchment at a time when the private sector is demonstrating a strong predisposition to save. That’s understandable. Given prevailing high levels of unemployment, low capacity utilization ratios, and relatively sluggish aggregate demand, a greater predisposition by the private sector to save makes greater sense.

Who, then, can fill that gap? If it doesn’t come from exports (and it’s impossible for all nations to run current surpluses), then only the government can fill that gap. A lack of jobs is the result of a lack of spending. The government has the capacity to provide that extra aggregate demand, and could do so easily by directly creating the necessary work. Instead, we appear more focused on union-busting and rewarding the figures most responsible for creating this crisis in the first place.