Reasons to be fearful… The German economy

Since the onset of the eurozone crisis in 2011, and the ensuing austerity across the Mediterranean, the health of the eurozone economy has been dependent on Germany and the desire of the German consumer to buy goods and services from the rest of Europe. Given the German cautious savings mentality and aversion to spend this has rarely been a winning economic strategy, but in fact the strength of the German labour market has given some succour to the eurozone economy in recent years.

This strength came from the jobs and pay from the German capital goods and autos sectors, demand for which held up due to strength from two key export markets, China and the Middle East. Over the last eighteen months, however, both of these economies have seen significant weakness. The Chinese government has reversed course on the massive public infrastructure investment programme it undertook from 2009 onwards and is now looking to rebalance its economic demand away from exports and investment and towards domestic consumption, where apart from autos, German industry is not well represented. While the oil price was comfortably above $100, then the oil exporting nations of the Middle East had lots of money to finance investment spending in their economies, but now that oil is trading below $50, this spending has dried up.

So these cyclical trends were already pointing to a slowing in demand for German goods and a consequent impact on German consumer confidence. In recent weeks there have two further hits to the German economy.

First, the extraordinary response of the country, led by Angela Merkel, to the refugee crisis, which will see 800,000, or 1%, of the population, immigrants allowed into the country in the near future. In the long term, as these people find jobs and pay taxes, this will be seen as supporting the German economy that was beginning to worry about its ageing population, but in the short term the economic impact is more likely to be a burden to the German government, since it will widen the budget deficit and this will likely lead to a tightening of fiscal policy elsewhere to remain with the balanced budget rule that Germany has now put in place.

Second is the Volkswagen scandal which erupted last week over the software coding in VW’s diesel cars that was designed to deceive regulators testing the emissions of these cars. This appears to drive a stake through a core German industrial USP, that of reliability, trustworthiness and quality. VW is the country’s largest employer and embodied much that the Germans felt good about themselves. It is too early to judge the effects of this scandal but they could be very significant not just on export demand for VW cars, but all German cars and possibly other German products too. Aside from this is the neagtie impact on the psyche of the German worker and consumer, who has never needed much excuse to feel they must save more now and spend less.

The new balanced budget rule means that a weaker German economy now leads directly to German austerity, and a further hit to the outlook for the eurozone economy.

The world economy needs more German spending not less. The German and Chinese economies are the two major creditor economies left in the world today – with the other major world economies running trade deficits, new demand in the global economy needs to come from consumers in these creditor economies. Without it, as is now looking increasingly likely, the global economy will remain very weak, and policy makers have few policy levers left to pull to boost it.