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Are we witnessing the second falling of the Berlin Wall?

September 25, 2019

September 25, 2019

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Are we witnessing the second falling of the Berlin Wall?

When everything started falling down around the ears of the Eurozone countries, one pillar stood tall and helped the entire Union withstand a global financial meltdown of unprecedented proportions. But just over ten years on from this momentous event, there are cracks beginning to appear in the base of the once sturdy German pillar.

When everything started falling down around the ears of the Eurozone countries, one pillar stood tall and helped the entire Union withstand a global financial meltdown of unprecedented proportions. But just over ten years on from this momentous event, there are cracks beginning to appear in the base of the once sturdy German pillar.

The German economy is suffering its worst downturn in almost seven years, after its second quarter of negative GDP growth in the past twelve months. If there is another consecutive quarter of negative growth reported for this quarter, Germany is officially in a recession.

The largest driver of this slowdown has been the damage down to the manufacturing sector by the ongoing US – China ‘trade war’. Manufacturing numbers in Q3 do not appear to have fared much better.

“The manufacturing numbers are simply awful,” Markit economist Phil Smith said of Germany. “All the uncertainty around trade wars, the outlook for the car industry and Brexit are paralyzing order books, with September seeing the worst performance from the sector since the depths of the financial crisis in 2009.”

On Tuesday, German Federal Minister for Economic Affairs, Peter Altmaier, insisted that Germany was not in a recession. But the numbers don’t suggest that there will be much to support his assertion. On Monday, the DAX index (tracking Germany’s 30 largest listed companies) dropped by over 1% as its manufacturing sector PMI (Purchasing Manager’s Index) dropped to a decade extreme of 41.4.

The PMI reading for the broad German economy also fell, slipping to 49.1 – the lowest reading in 83 months, suggesting that the fourth biggest economy in the world is in recession.

The immediate future does not appear much rosier either, with Jamie Rush, an economist at Bloomberg, predicting that alongside the slowing of the service sector, Q4 will be another poor quarter for economic growth.

So if the problem is an economic slowdown driven by a curtailing of the manufacturing sector, what is the solution?

Most modern governments have opted for fiscal stimulus. As made famous by the 2008 financial crisis, this has commonly taken the form of quantitative easing (QE), the process of a central bank hoovering up government bonds and other market assets to inject liquidity into the system. Evocatively, this is often portrayed as the central bank literally ‘printing’ money in order to reignite capital flow. As countries like Zimbabwe and Venezuela have discovered in the past however, QE has its limits as a fiscal policy. Scale matters, and the more widely adopted a country’s currency, the more it is likely to withstand the significant use of QE.

In the Eurozone, it became so popular that it spawned multiple rounds, inventively named QE1, QE2, QE3, and so forth. But QE hasn’t stopped since the period of the GFC drew to a close. In fact, recently departed European Central Bank chief Mario Draghi announced in September that the ECB would buy €20 billion of debt a month from November 2019 onwards.

Often accused of being the puppet-master of the EU, and the mastermind behind the ill-fated attempts at forcing economic reform in Greece, the Germans have nevertheless taken a strong opposing view to that of the ECB on economic stimulus and QE. Famously frugal, the only serious example of fiscal stimulus from the German government since the two halves of the country reunified in 1990 indeed came in 2008 when €50 billion euros was injected to keep its manufacturers afloat. When compared with the US$700 billion TARP rescue package put together by the US government at the same time, it pales into insignificance.

Part of the reluctance has been a historic refusal by successive German governments to run a sustained budget deficit. Angela Merkel’s government has run budget surpluses since 2014, ignoring criticisms that in a global economy with historically low interest rates, now would be the time to invest in infrastructure.

This reticence has given Germany a lot of headroom to act now however, if chooses to do so. Its budget surplus for the past year is 2.3% of GDP, and in comparison to the other large continental powerhouse economies, its public debt to GDP ratio is two-thirds that of France, and half that of Italy. More promising still are statements from Olaf Scholz, the country’s finance minister, who insisted that Germany would act to counteract another financial crisis. The perceptive reader would no doubt immediately identify of course that this suggests a willingness to be reactive, but not proactive however.

Reflecting on how the German malaise may affect investors closer to home, the impacts theoretically could be felt through the Australia – EU trade deal that is in the process of being hammered out. It should be noted though that a concluded trade deal is likely some way in the future, as there remain notable disagreements between the two sides. In relation to the export of cars, for example, an industry the Germans are considered unsurpassed in, current Australian fuel regulations likely mean that the top of the line German vehicles will never even make it to our shores.

This is because they are being designed with EU fuel regulations in mind, which permit less than 7% of sulphur content that unleaded 91, the most popular fuel at the Australian fuel pump, contains. Should Australian investors with an eye on Berlin be concerned about the long term prospects of the Germans?

Probably not is the answer – Germany remains blessed with extremely low unemployment, and is presently undergoing through a significant political transformation, as the 15-year reign of Angela Merkel has already begun its crescendo. Fundamentally, Germany appears a structurally sound economy that has been damaged by the economic cycle, driven by the tit-for-tat nature of the tariff war. And there has been one area where the German government has shown a willingness to intervene; it recently issued a €50 billion Green Bond to stimulate the market for green technology, amongst other renewable initiatives.


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