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What is the secret to Germany’s economic success, part 2?

Data out today show that German economic growth slowed sharply in the last quarter, with the economy growing at a weak 0.1% rate in the April-June quarter. Growth in the previous quarter was also revised down. to 1.3% from 1.5%.

Moreover while the euro zone-wide slowdown was not as severe, the data do show growth slowing from 0.8% in Q1 to 0.2% in the latest quarter. In essence, the euro zone economy is at stall speed and on the verge of recession.

Let me say a few words about Germany’s economic success in light of the latest data.

First, whenever I write a post, I like to look into my archives and see what I have said about the topic in the past. That usually means I end up linking to and quoting those posts as a mental note for myself, but also as a quality check. It’s easy to say one thing due to the exigent circumstances of the times and then flip-flop to saying something else three months later. my links serve as my way of avoiding this.

When I checked in the archives, here’s what I found first:

The bottom line: the fundamentals of the German economy are relatively good and support continued long-term growth.

Nevertheless, I am sceptical of the pace of German recovery for two reasons. First, Germany is fully integrated with the rest of Europe where many economies are struggling with debt issues, weakening demand for German exports…

Second, domestic demand remains weak in Germany. …German retail sales increased 1.2% in 2010… That this weak 1.2% increase in 2010 is the highest reading since 2005 and cause for optimism tells you that domestic demand growth is a sticky wicket for the German economy. Demographic factors almost certainly come into play here… [Claus Vistesen’s] post on an aging… points to an increasing burden from Germany’s social programs for pensioners. And German national debt of over 77% of GDP reflects this burden.

These headwinds point to moderating growth. And if the European periphery spirals down, it will drag Germany down with it via trade and financial linkages. Germany needs to develop internal demand, especially if it is going to pay for its social programs…

Overall, we should credit Germany for building a recovery based not just on exports, but on capital investment and saving. One reason that Germany is a manufacturing and export powerhouse is because it has invested in those businesses… And that is definitely worthy of emulation.

-What is the secret to Germany’s economic success?

I stole the title from that post because I want to expand on it here. Germany has a large internal domestic economy that insulates it from exogenous shocks much as America’s large economy does. However, this effect only goes so far. So, this time, rather than extol Germany for the virtues of its economic success I want to talk more at length about the growth problems there.

Demographics

First, Notice that a decline in household spending was a major contributor to the fall in Germany’s growth. Germany is aging. And that speaks to declining consumption demand and declining growth – just as it does in Italy and Japan, two other advanced economies mired in near zero growth with similar demographics. This is what is killing those highly indebted nations.

Look at the chart below and you can see the slowing growth.

German Long Term GDP

Germany is trade-dependent

Moreover, there is also the trade connection. Germany’s export machinery creates a lot of economic volatility. That’s why German’s lead export group is pushing for Eurobonds. As I put it when the sovereign debt crisis was first beginning, Spain’s debt woes and Germany’s intransigence lead to double dip.

If Spain is forced to run austerity measures as seems likely, in stage two, this shifts their government deficit markedly down. Given Spain’s poor labour competitiveness, sticky wage prices and inability to depreciate the currency, all of the adjustment falls onto the private sector in the form of reduced net savings (which could include larger debt burdens). But, the thing to realize is that total GDP in Spain is lower in this scenario, which means total imports are lower, which means Germany’s total export volume is lower. This is a deflationary scenario.

And I use Spain here as a metaphor for the entire periphery. The euro zone is on the verge of a double dip, especially in view of the contractionary fiscal policies in the periphery. There is zero chance Germany can escape this unscathed.

Germany’s banks are under-capitalised

Everyone knows the peripheral bailouts are about German and French banks. The European banks were undercapitalised before the crisis and are still undercapitalised today. The real problem for the Germans is the recklessness of their banking sector. We saw the bailouts of Commerzbank, IKB and WestLB, HSH Nordbanken, and so on. The Irish debacle is about bankers gone wild in Ireland AND Germany. I should also point out how reckless German banks like Hypo Real Estate have been implicated in misadventures in Spain. And just to reinforce how wild German banks went, we have to remember that even Deutsche Bank, the biggest and most well-respected German bank, was getting hand outs from the U.S Federal Reserve to prevent its insolvency during the liquidity crisis in 2008-2009. In terms of economic weakness, this may be less relevant. But in terms of potential sovereign defaults or a banking crisis it is very relevant.

Germany does have a high debt load

I think this graphic from Die Welt makes that clear. Germany’s fiscal record is significantly worse than Spain’s over the last decade before the credit crisis such that it still has a higher debt-to-GDP ratio even today.

National Debt comparison

My point: There are a lot of reasons Germany has been doing well: wage restraint, educated workforce, low unemployment, etc. I could go on and on. But in a global growth slowdown, the Germans will not be immune any more this go round than they were last time when their contracted more violently than most along with the other export-dependent aging society, Japan. Austerity in the west, debt overhangs in the periphery and monetary tightening in emerging markets will act to slow demand globally. And this will certainly impact Germany.

If Germany wants continued economic success, its government must do a much better job in leading the euro zone out of its existential crisis. If the periphery sinks, we all sink.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

11 Comments

  1. Germany just uses the eurozone as a neo-mercantilist mechanism for flooding its less-competitive ‘EU partners’ with its exports while using the devalued Euro to sell its exports abroad.

  2. they’re going to get sucked into the sluggish growth vortex. Join us Germany, join us.

  3. bad enough the cancerous and healthy economies are tethered by the Euro. In a better global economy it may work. In this one it was only a matter of time until Germany suffers. And that entire region can’t afford at all sluggish growth from any healthy sovereigns for very long

  4. Thomas says:

    About 40-50% of Germany’s Exports go to the Eurozone..The rest are exported around the world. Germany is the largest Manufacturer of High-end/High Tech Products while Japan is second. Germany uses Eurozone? Germany was Greatly responsible for Building up many of these Countries with Transfers of money over the years through the European Budget…Roads,Airports, Ports, Dams, Electrical Systems, Factories, etc in places like Greece or Spain or Portugal were paid for by countries like Germany. These Countries now have forgotten this and want their cake too. Greece is the most Corrupt and many do not pay taxes, they spend to much on the military, etc. Greece wants to blame Germany? Greece really never had much of an Export Economy or Manufacturing base(A Small one)so when the Euro Came in Greece had choices to build their country further or Spend the low interest loans from the Euro-membership on Consumption/Corruption and Waste! Greece went down the wrong path and so they blame Germany even though much of their modern Country now is because of German and French, etc…Transfers of wealth for years! Germany Exports around the Globe and they had the largest Trade Surplus and Exports in the 1988-1989 time frame before they started rebuilding the East side of Germany…Explain why Germany for many years(a small country) had the world’s Second largest Exports going back to the 1960′s right up to 1988-1989 when it became the largest exporter and again in the 2000′s when it became export champian again outpacing America and China? Not one mention of Germany’s Technology Level nor Engineering Genius? Greece could devalue it’s old Currency all it wanted still it would not be able to compete with Germany with or without the Euro, Greece had Trade Deficits with Germany going back many years before the Euro. Germany’s Codertmination, Work Councils, Social Economy, Free Vocational/Techical/College Education, Healthcare, Infrastructure, Sustainable Developments, etc is why Germany is so strong not just the Euro. Germany and others are uniting the EU into one because that leads to more Stability and Power and Wealth….How is Greece going to “Compete with China?” and without the Northern Creditor Nations money Greece would still be a Military Dictatorship back-water. All that new Infrastructure in Spain? The Spainish Paid half and the Rich Creditor Countries(Like Germany) paid a large sum. Like California transfering 70 or 80 billion dollars(a year) through federal tax transfers to states like South Carolina, Arkansas, etc…These Conservative Neo-con states spit in the face of States like California, New York, illinois, etc while taking these huge sums of money. I calculated that over 300 billion a year was transfered from Blue States to Red States in 2008! 300 Billion!!!! over a Decade that would be 3 Trillion! What is California getting out of this deal or the other Creditor States? It worked for while but now South Carolina and others are trying to destroy the Creditors Economies and power luring German and Japanese, etc companies into their states giving them huge sums of money(which they can afford because all of their basic expenses are being paid for by the Creditor States(Roads, etc)while trying to take out Ford, GM and lure other industry away the very states propping them up.

  5. Gosh, that’s a very large block of text without a paragraph break. I wasn’t trying to denigrate the real competitiveness of German exports, they are well deserved, of fine quality and rendered from significant home-grown R&D efforts. I’m just saying that they aren’t altruists, they like the Euro because it makes them even more competitive due to the worse performing nations in the union. I think they would be better off with their own currencies so they don’t have to engage so much in internal depreciation, they can do it through the exchange rate.

    I’m not so brushed up on knowledge vis-a-vis Germany and its infrastructure projects with the rest of Europe, but I would have guessed those were projects between the German private sector and the Spanish/Greek public sector rather than public sector – to – public sector.

    I also think you may be painting too fine a picture of Germany, the country has had unemployment rates around 8 percent for a decade pre-GFC, is too export-dependent (not everyone can be can exporter, it’s deflationary), adverse productivity between 2007 and 2009 (GDP per employee falling 5 percent), and real earnings in the country dopped by 4.5 over the past decade.

  6. man. sweet Edward

  7. chewitup says:

    Did anyone check out Michael Lewis article in Sept. Vanity Fair? Qiute good.

    http://www.vanityfair.com/business/features/2011/09/europe-201109

    • I didn’t like it, actually. It had a bizarre fixation with crap – some sort of running metaphor for the assets that Germans bought. This was juvenile rather than funny. And it was well over the top in terms of the allusions to Nazis and national stereotyping. I found it cringe-worthy at times because the stereotyping revealed a parochialism in Lewis’ own viewpoint that makes me want to re-examine his biases elsewhere. For me at least that taints his other work because it will cause me to look at it all through that prism.

      See here:

      http://blogs.reuters.com/felix-salmon/2011/08/14/feces-fascists-and-michael-lewis

      • chewitup says:

        It did have a Matt Taibbi feel to it. (Per the second comment in Felix’s piece.)

  8. NOTaREALmerican says:

    Re: What is the secret to Germany’s economic success, part 2?

    Not sure you actually answered the correct question. You’ve basically said: Germany is successful because Germany is economically successful.

    What allowed Germany to position itself (say over the last 30 years) to be economically successful? Educated work-force? Ok, why? Exports of high quality “stuff”? Ok, why didn’t they send all those jobs to China and have all the Germans be “knowledge workers”?

    • Actually the title is a bit facetious because as I indicated in the text I am talking here more about the problems than success. The whole point of the post is this:

      “in a global growth slowdown, the Germans will not be immune any more this go round than they were last time when their contracted more violently than most along with the other export-dependent aging society, Japan. Austerity in the west, debt overhangs in the periphery and monetary tightening in emerging markets will act to slow demand globally. And this will certainly impact Germany.”