Germany IS About To Have Its Worst Recession Since WWII

The German economy is about to suffer its deepest recession since World War II according to economics Minister Michael Glos speaking in an interview with the German newspaper Welt am Sonntag due to be published tomorrow (Sunday). Glos said growth in Europe’s largest economy is now expected to drop by as much as 2.5 percent this year (and there is still downside risk here). Earlier government estimates had been for slight positive growth (0.2 percent). This suggests that the miracle export-driven-recovery in German economic performance that so many were enthusing about in 2007 has actually been a short lived, one-off, affair, driven largely by an unsustainable lending boom in the UK, and Southern and Eastern Europe. If we take as good this year’s government estimate, it gives us average growth for the German economy over the last 10 years of 1.07%, hardly changed from the supposedly “correctional” pace attained between 1995 and 2005 (see chart below) – or is Germany’s lost decade now surreptitiously going to convert itself (like its Japanese equivalent) into the lost decade and a half?

Germany’s economy started contracting in the second quarter of 2008, and went officially into recession in third quarter. Further the Federal Statistical Office estimated this week that the economy may have shrunk quarter on quarter by as much as 2 percent in the fourth quarter (ie at an annual contraction rate of 8%), and that annual growth for 2008 may have been as low as 1.3 percent (non calendar adjusted – 1% calendar adjusted) – about half the 2007 level.

Was any of this foreseeable? Well I was predicting annual GDP growth in the 1.3/1.4% range for 2008 back in July last year (see this post on RGE Monitor), and I have attempted to raise an alert about the possibility of Germany falling into deflation (this post here), a risk I now think to be real and immediate with a contraction in GDP of between 2% and 5% (which I think is where we are, and it wouldn’t surprise me to see the 2009 number coming in at the steeper end of this range. I mean I think there is more bad news coming in Southern and Eastern Europe that has not been factored-in yet).

Germany’s inflation rate fell to its lowest in more than two years in December, declining to a 1.1 percent annual rate from 1.4 percent in Novembe. That’s the lowest level since October 2006.

“With inflation in Europe’s largest economy dropping at that speed, the ECB has all the legitimacy it needs to cut rates rapidly,” said Jens Kramer, an economist at NordLB in Hannover. “German inflation will actually turn negative by the middle of the year.”

Month on month prices actually rose 0.4 percent, and in fact both the general and the core indices spiked upwards at the end of last year (see chart), but given the extent of the contraction which we can expect, I really don’t think that this is going to be very typical.

And The German Labour Market Has Finally Turned

Unemployment in Germany rose last month for the first time since February 2006, thus bringing inauspiciously to an end an unprecedented 34 month labour-market recovery. Figures released by the Federal Labour Agency last week show that the number of those seeking employment in Germany rose by a seasonally-adjusted 18,000 in December. The change is small, but the significance is great, since this is obviously but the first month of many when unemployment will rise in Germany, and this rising unemployment will now, in its turn, feed back into the industrial slowdown which is already underway. The seasonally adjusted unemployment rate remained unchanged (following data revisions for previous months) at 7.6 percent.

This is hardly a surprise, but it is certainly not good news.

In a separate release the Federal Statistical Office reported that the number of persons in employment living in Germany was 40.83 million in November 2008 – up by 500,000 persons on the same month a year earlier. However, the relative increase (+1.2%) was the lowest rate of growth since December 2006. In January 2008, the relative increase compared with a year earlier was 1.7%. So the economic downturn is finally beginning to show up in the labour market, too.

As compared with October 2008, there were 12,000 more people working which compares with an average increase of 53,000 in November 2005, 2006 and 2007.

Exports Drop Sharply In November

The reasons for the uptick in German unemployment are not hard to find, since German exports fell back at a record rate in November – in fact seasonally and working day adjusted current-price sales exports fell back 10.6 percent from October (when they declined 0.6 percent), according to the latest data from the Federal Statistics Office. This is the biggest monthly drop since records for a reunified Germany began. November exports dropped 12 percent year on year, while imports fell 5.6 percent on the month and 0.9 percent from a year earlier. The trade surplus (which is the key consideration when it comes to GDP growth) narrowed to 9.7 billion euros from 16.4 billion euros in October, and almost half the April rate of 18.8 billion euros. The current account surplus was down to 8.6 billion euros.

The immediate future looks even worse, with the latest data from the Technology Ministry showing new orders fell 27.2% (on aggregate) in November (as compared with November 2007) following a 17.5% annual reduction in October, while export orders fell back 30% year on year.

In fact it has been the sharp drop in orderswhich has sent Germany’s manufacturing sector into headlong contraction, and the sector shrank at the fastest rate in over 12 years in December, with the Markit Purchasing Managers’ Index (PMI) falling to 32.7 – down from 35.7 in November. The reading, which showed the sector contracting for the fifth month running, was the lowest since the series began in April 1996, while the sub-index for new orders also fell to a series record low.

Fiscal Deficit Worries

So what can the German government do? Well quite little at this stage of the game I think. Obviously the ECB can (and should) be taking steps to move into line with the Federal Reserve and the Bank of Japan and start readying up some sort of “European” version of quantitative easing, but as far as the national government goes, then I think we are near to the hang on tight and keep your fingers crossed stage. Chancellor Angela Merkel’s governing coalition did agree this week to a further 50 billion euro economic stimulus plan which includes items like investments in infrastructure, and tax relief and payments for families with children. This follows an earlier plan worth 23 billion euro, which was criticized at home and abroad as being too cautious.

But what I think most observers don’t appreciate sufficiently is that in an export-driven economy, where population ageing means that domestic consumption is simply not going to take up the slack and drive the economy, then there is simply a limit to what any government can do – without spending money which is going to be badly needed to pay future pension and health care costs, that is. German Finance Minister Peer Steinbrueck admitted in a newspaper interview with Financial Times Deutschland that he now expected Germany’s fiscal deficit to exceed 4 percent of gross domestic product in 2010 taking into account the latest stimulus plan. The issue here isn’t simply that EU rules require member states to rein in deficits to no more than 3 percent of gross domestic product (and cap national debt at not more than 60 percent of GDP), we are in an emergency and emergency measures are needed.

But EU member states also agreed in April 2007 to balance budgets by 2010, and Germany had been very critical of France for saying they would not be able to meet this target. Germany had already violated the deficit rule for four straight years between 2002 and 2005.

“Of course I would have liked to present you with proof at the end of the legislative period that we would manage to have a budget without new borrowing in 2011. Under normal circumstances, we would have managed that,” Steinbrueck said. “But we are dealing with a sharp recession, an enormous financial crisis and a crisis in the auto sector.”

The point is that falling back on this target will not come cheaply, in the sense that balancing the books was agreed to for a reason – the need to meet the costs of sustaining a society with a rapidly rising elderly dependency ratio. There is a lot of discussion of widening eurozone bond spreads in the eurozone at this moment, but I find myself asking one simple question: if investors start to get worried about the sustainability of German financing, whose bond will become the benchmark against which the other spreads will rise, France’s perhaps?

“A balanced budget remains our target because the demographic changes in Germany will increasingly have an effect from the middle of the coming decade. We must not overburden the younger ones,” Merkel said.

Black Hole In The Banking System?

And there aren’t only holes in the real economy to try and plug (with cement), the financial sector is also becoming an apparently bottomless pit, with the government being poised on Friday to step in and part-nationalise a second bank. Hypo Real Estate is once more in emergency talks with Germany’s bank rescue fund about a deal that looks likely to give the government a stake in the troubled investment bank. These negotiations draw a difficult week for the German banking sector to a close, following the announcement by Deutsche Bank of a 4.8 billion trading loss in the last three months of 2008 (which compares with a profit of about 1 billion euros a year earlier) while landesbank WestLB prepared to warehouse risky investments. WestLB wrote to its owners, local savings banks saying it needed to park troubled assets off its balance sheet in order to stage a recovery – the value of the doubtful assets involved is thought to be about 50 billion euros.

Munich-based Hypo Real Estate on 12 January received an extension until April 15 on a 30 billion-euro framework guarantee provided by Soffin, Germany’s bank-rescue fund. The lender said at the time that talks with Soffin regarding more extensive and longer-term liquidity and capital support measures are continuing. Commerzbank AG, Germany’s second-biggest bank, got a second state bailout on 8 January to strengthen its capital following the acquisition of rival Dresdner Bank from insurer Allianz SE. The German government in return agreed to take a stake of 25 percent plus one share in the combined Commerzbank-Dresdner.

And there is more to come, much more. Der Spiegel is reporting that the major German banks have so far written off only around a quarter of the nearly 300 billion euros in toxic U.S. assets they have on their books. The finance ministry in Berlin estimates that the entire German banking sector is carrying around 1000 billion euros of risky assets on its books, according to Der Spiegel. The government has aset up a 480 billion euro rescue fund to provide fresh capital or lending guarantees to the financial sector, and has already committed 100 billion of the 400 billion set aside for loan guarantees and 18 billion of the 80 billion earmarked for capital injections. However, some see even this as insufficient and there have been mounting calls for the creation of a “bad bank” that would buy up risky bank assets.

Finance Minister Peer Steinbrueck was quoted by the Frankfurt Allgemeine Sonntagszeitung weekly newspaper as saying he could “not imagine (such a step) economically or above all politically”. A bad bank would need to be financed with 150 billion to 200 billion euros of taxpayer funds, he said. “How am I supposed to present that to parliament? People would say we are crazy.”

China Pushes Germany Into Fourth Place

And to add insult to injury, China this week announced that it had become the world’s third-largest economy, surpassing Germany and closing in rapidly on Japan, according to Chinese government and World Bank figures. The Chinese government revised its growth figures for 2007 from 11.9 percent to 13 percent, bringing its estimated gross domestic product to $3.4 trillion, about 3 percent more than Germany’s $3.3 trillion, based on World Bank estimates. Even though China’s growth is now dropping rapidly – and some estimates suggest it may only be 6% in 2008, Japan’s is currently shrinking, and the growth differential is sure to remain, however bad China’s performance actually does turn out to be in 2009 and 2010. Hence I don’t think it will be that many years before China’s GDP manages to overtake Japan’s, which is currently estimated to be worth around $4.3 trillion.

This entry was posted in A Few Euros More, A Fistful Of Euros, Demographics, Economics by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

8 thoughts on “Germany IS About To Have Its Worst Recession Since WWII

  1. I know first hand that German industrial equipment is sold in huge quantities over the world. If BRIC and another dozen of emerging economies will recover (and most probably they will, and quite fast), Germany economy will recover quit nicely.

  2. Hi,

    “If BRIC and another dozen of emerging economies will recover (and most probably they will, and quite fast), Germany economy will recover quit nicely.”

    Well, I think the BRIC just split in two, since according to the analysis I am just writing China and Russia are among the worst affected in the current depression. So conceptually BRICs as a concept is now history, it is simply size that matters, but population age structure.

    Brazil and India are much better, but even they are having a hard time, although the may well lead the recovery when they do start to fire on all cylinders. But just how quickly will quickly be here? Certainly it won’t start in 2009. If Brazil and India can steady up in 2009 they will be doing well. Possibly things will improve on this front in 2010, but these are both areas where up to now Germany has not been especially well positioned, and I expect the US and Japan to get more of the impetus here even when it comes. Germany has been too focused in Central and Eastern Europe, and this will come with a price tag attached.

    I see at least a couple of years of hard times and pain for the German economy, and this has downside risk attached.

  3. Edward, I am probably being overoptimistic (sinful, sorry), but I count on restructuring efforts of Chinese, Indian, and Brazil economies. These countries have at least two decades worth of projects to upgrade their civil infrastructure. And I mean not only roads, power stations, airports, and alike, which is subject to downturn in export-oriented economies. I am talking about things which should be done anyway, and in time of recession projects like city drainage/sewage collection and treatment, coal power stations emission treatment (SOx, NOx, PM; CO2 is for dummies) are much cheaper to accomplish. This positions Germany as foremost beneficiary of equipment procurement and licensing. Note, that this scenario is unlikely in Russia and Eastern Europe, where such infrastructure is quite decent.

    Second possibility is upgrading of information highways, like cable/phone/internet infrastructure, computerization of schools and universities, and alike. In such scenario US and Japanese companies will benefit most. Honestly, I do not anticipate such scenario on the scale meaningful in national GDP numbers.

    Third, there is mining. Downturn or not, mines exhaust their reserves pretty fast, and appetite for commodities is cooled, but nowhere seriously destructed in medium turn. Germany and Japan are big in supplying such equipment.

  4. Hi

    “Edward, I am probably being overoptimistic (sinful, sorry), but I count on restructuring efforts of Chinese, Indian, and Brazil economies.”

    Well, the consensus is more or less with you, so you don’t have to apologise. I just don’t see China kick-starting anything in her present condition I’m afraid – see my post on the Russian GDP indicator, and Brazil will need oil and commodity prices to start to rise (or at least investors seeing the likelihood of them doing so) to get going. India looks like it will muddle through, without too much structural damage, but can’t pull the whole train on its own.

    I mean, obviously we will get a recovery, and more or less I agree with you about what it will look like, I just think it is going to take longer than people are expecting, and I’m still not sure what can get the mindset moving again.

    Also, Germany is particularly badly placed, due to the over dependence on Eastern Europe. Selling is not just about signing people up, you need sales networks, contacts, people on the ground, plug-ins to government etc.

    For example, Spain has few viable export industries at this point, but if it did have more of them the n Latin America would be a gift, since the networks are up and running, and the influence is strong. This is what Germany lacks. It is starting from virtually zero in India (India could be very good for the UK and the US, of course) and was only selling as much to China as it was to the Czech Republic before the roof fell in.

  5. AL,

    The World Bank certainly don’t see the kind of uptick in investment that you are talking about this year.

    Foreign direct investment in developing nations will drop by $180 billion, or 31 percent, this year as a global recession prompts multinationals to cut spending on factories and mines, according to the World Bank. Foreign direct investment fell an estimated 10 percent in the developing world in 2008 and will cool further this year, the United Nations said in its 2009 outlook. FDI, which typically involves spending on plant and machinery or the purchase of a controlling interest, accounted for 38 percent of inflows into emerging markets in recent years, compared with 10 percent for investment by funds and 54 percent for loans, according to Morgan Stanley estimates.

    Rio, the third-largest mining company, this month postponed a $2.15 billion expansion of an iron-ore mine in Brazil. Honda, Japan’s No. 2 automaker, delayed construction of a $100 million factory in Argentina and has shelved expansion plans in Turkey and India. Hitachi Construction Machinery Co., the world’s largest maker of giant excavators, froze a $1 billion plan to expand production in China and other emerging markets. “I’ve never before experienced seeing sudden, simultaneous drops in worldwide demand,” Hitachi Chief Executive Officer Michijiro Kikawa said this month in an interview in Tokyo. “New investment won’t be implemented until we can foresee how the market will recover.”

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