Could There Really Be A Recession Risk In Germany?

Oh, come on Edward, surely this time you are going too far? The Germany economy is the strongest in Europe, time and again we have been told it is powering and powering ahead. It has just demonstrated record growth performances. So where the hell could you possibly get the crazy idea that Germany might be in for a double-dip recession? Must be the summer Spanish heat.

Well, no. Perhaps the idea is not as absurd as it seems at first sight. Try taking a look at this chart (exhibit A), for starters. This is what just happened to German manufacturing industry.



It is the monthly manufacturing PMI chart, and note the sharp smooth downward line, which stretches from February's high point of 62.7, down to July's 52. Yes, German manufacturing industry is still expanding, but only just, and it is the pace of the slowdown which is remarkable.

And this months report made plain there is worse to come, since as Tim Moore, senior economist at Markit informed us: “New order levels went into reverse in July, as fewer export sales helped end a two-year period of sustained growth". The report also highlighted a reduction in export sales, with the pace of contraction being the fastest since June 2009.

We can also find a reflection of what we are seeing in Germany out in East European economies like the Czech Republic, where the rate of economic expansion has also slowed sharply. This is not surprising, since these economies are all tightly roped together via the German export machine.



Well, OK, German manufacturing industry is slowing, but that's only one part of German activity, surely the rest of the economy will have sufficient momentum to keep moving forward? We this is where I bring in what I consider to be my "killer app", which is the fact that Germany has an export dependent economy.



In Germany movements in GDP follow movements in the rate of expansion of exports. Let's not get into why that is for the moment (think Germany's particular demography), and just consider the possibility, despite all the talk over the years of Germany finally "decoupling", that it can't. Export dependence could well be the key explantaion for why the performance of the German economy is so "extreme" and so volatile, with quarters of record growth being witnessed just before the onset of substantial recessions, recessions which often register record falls in output only to be followed by massive recoveries. The reality is not that Germany is either a growth or a contraction champion, but that export dependency simply makes the German economy more volatile and more susceptible to sudden changes than those of some of its neighbours (like France).



In fact Germany's long term trend growth has been falling steadily.





We Can See The Slowdown Everywhere, Except In The ECB Rate Policy

But why do you insist that this won't simply be a slow patch, or a soft spot? Even the bundesbank is saying that German growth in the second half of the year won't be as strong as in the first half. Well, here comes exhibit B. The slowdown is global, and for an economy which needs growing exports to grow, then a global slowdown is a real problem.






Even China (that other great export driven economy) is feeling the heat, with new export orders also having slid into contraction territory.



And there are more indications than simply the PMI that the economic outlook in Germany is deteriorating. We have the IFO sentiment index, which has now entered overall decline.



And then there is the latest European Confidence Index reading:




Naturally, none of these readings are definitive, but they are what we have at this point, since data from June is hardly helpful to tell us what will happen in August, which is why we need to rely on the "softer" forward looking indicators.

And obviously I can only discern something about the situation such as it is now. Should Ben Bernanke (as I argued in this post here) decide to go ahead with another bout of quantitative easing, Germany would probably be one of the leading beneficiaries, but that is the world we might have, and not the one we actually have as of this moment. So summing up I cannot do better than Tim Moore, senior economist at Markit and author of the PMI report, who said in his final comment:

“July’s final PMI data confirmed a sharp slowdown in German private sector growth, with output levels rising at the weakest pace since the autumn of 2009. The month-on-month loss of growth momentum was also the steepest since the recovery began two years ago. New business gains meanwhile hit a stumbling block in July as heightened economic and financial market uncertainty encouraged clients to delay spending decisions. The latest overall rise in new order levels was the slowest since the start of the upturn, which in turn is likely to weigh on business confidence and job hiring in the months ahead.”

This post first appeared on my Roubini Global Econmonitor Blog "Don't Shoot The Messenger".

The Odd Couple

The modern world moves at a breathtaking pace, even when most of us find ourselves on holiday. No sooner do we receive, read and start to digest one set of economic data than we find ourselves pushed to think about what the next set will look like. The clearest recent illustration of this undoubted reality is to be found in peculiar twist of events which meant that just as the news reached us that the German economy had expanded at a record rate in the second quarter, at almost the very same moment Federal Reserve officials meeting in Washington decided to significantly downgrade their economic outlook for the United States, saying the “pace of recovery in output and employment had slowed in recent months” and was likely to be “more modest” than anticipated in the near term. But this followed a month of May when it seemed Europe's economies were on the brink of disaster, while over in the United States some sort of recovery was on the cards.

So what is going on here, does the earth switch it’s magnetic pole every six months, with what went up last time round now going down? Or could it possibly be some kind of common thread here, one common factor which unites the unprecedented expansion we have just seen in Germany, and the fears of renewed recession in the United States. Well, as it happens, indeed there could, and it has a name - the Greek debt crisis.

Structural Problems In The Currency Architecture?

So what is the link? Well, the fact of the matter is that we live in a bi-polar world, at least as far as currencies are concerned. Until our current global financial architecture evolves into something more sophistocated, we have two main currencies which rival one another for pride of place in central bank reserves and investment portfolios: the euro and the dollar, and when one of these goes up, the other must come down, and vice versa. It is as simple, and as complicated, as that.

Prior to February, and the outbreak of the European Sovereign Debt Crisis the US economy was seen as the weaker partner, and the euro was priced at a relatively high level. Then the euro slumped (falling at one point from around 135 to 120 to the US dollar in a matter of weeks) as attention focused on what appeared to be significant weaknesses in the Eurozone infrastructure. As a result of the change German exports boomed, while the US economic recovery steadily started to grind to a halt.

And with the rise of the dollar the global economy started to fall back into dangerous - pre crisis – habits. The US trade deficit started to open up again, and one exporting nation after another started to see yet one more time the US market as the global economy's consumer of last resort. Indeed the US June trade statistics reveal the extent to which American consumers are once more sucking in large quantities of imports as their spending power recovers, while weak demand in the rest of the world coupled with the comparatively high dollar has been keeping a brake on American exports.

As the New York Times put it in an editorial, "China is mopping up demand everywhere you look with its artificially cheap supply of goods, while Germany, the world’s other exporting power, is cutting its budget and relying on foreign demand to drive its economic rebound. This isn’t sustainable".


And the numbers prove the point. The United States trade deficit ballooned to $49.9 billion in June, the biggest since October 2008. In July, one month later, China recorded a $28.7 billion trade surplus, the biggest since January 2009. In the first five months of the year, Germany’s trade surplus, driven in large part by demand for machine tools in recovering Asian economies (many of them busily sending exports to the US), rose 30 percent compared with 2009.

And this impression is only confirmed when we come to look at the latest revision for US GDP in the second quarter. According to the revised data, US GDP increased at an annualised 1.6% rate (as compared with the 9% annual rate in Germany), after registering a 3.7% rate in the first quarter, according to the Bureau of Economic Analysis (BEA) today. The second-quarter growth rate was revised down by 0.8 percentage point from the “advance” estimate (of 2.4%), in part as a result of the new data on imports for June. The US Bureau of Economic Analysis report stated that slower GDP growth primarily reflected a surge in imports compared with the previous quarter and a slowdown in inventory investment. In fact, real exports of goods and services increased at a 9.1% rate in the second quarter, compared with an increase of 11.4% in the first, while real imports of goods and services increased by 32.4%, compared with an increase of 11.2% in Q1.

Effectively the American economy is simply too weak to carry this additional load, and is now showing signs of heading back towards recession, forcing the Federal reserve, which only a few months ago was moving towards a tightening in monetary policy to fend off inflation to now re-assert its policy of quantitative easing to avoid any posssibility of a drift towards deflation.

Meanwhile the German economy turns in a 2.2 per cent quarterly growth spurt, unified Germany’s best-ever performance. The annualised 9 per cent growth rate, is, as the Financial Times noted, virtually unprecedented in developed economy terms. Such dramatic changes, rather than reassuring us that all is well, only lead to even more doubts. Is it really desireable for an economy to shoot forward so dramatically, only to fall back again in the second half, which is what almost everyone (Monsieur Trichet included) expects to happen?

Not only does the German performance seem exaggeratedly large, at the other end, on Europe's periphery, the result was lamentably small. Greece naturally exceeded everyone's expectations, on the downside, with a 1.5 per cent quarterly contraction (a 6 per cent annual rate), but Spain remained at the bottom end of the range, with a 0.2 per cent expansion, as did Portugal. Undoubtedly the Greek contraction will slow as the year advances, but the outlook there continues to be preoccupying. Only today the Greek manufacturing PMI, which showed the contraction in Greece's industrial sector accelerated again in August, has reminded us of just how difficult it is going to be for the country to return to growth, and especially if the external environment now starts to deteriorate.



As the FT's David Oakley said yesterday, in many ways Germany could be said to have had a "good crisis", since the Greek issue pushed the Euro down and German exports up, while the current flight to safety is driving down the yield on German bunds to record lows even as it pushes up the spreads for peripheral Europe sovereigns. Among other imapcts this gives German companies an even greater competitive advantage as their capital costs come down even while those for their competitors go up.

Spreads – which are the additional borrowing premiums countries have to pay over benchmark Bunds – hit a fresh record of 357 basis points in Ireland this week, following problems in Allied Irish bank and a Standard & Poor's downgrade. In Portugal and Spain, spreads have been creeping back up, and are now once more close to their all-time highs. Spain’s 10-year bonds are trading at about 192 basis points above Germany, compared with 57 at the start of the year while Portugal is trading at 333 basis points, compared with 67 on January 1. The following chart shows how peripheral spreads have evolved since the start of the year (they have been indexed to 1st January). As is evident they shot up in May, then came down to lower levels in July, but during August they have once more been climbing.



All three economies are experiencing extremely weak growth and Ireland is even flirting with deflation. Higher government borrowing costs can harm economies in a number of ways, from higher borrowing costs for companies to added pressure on a country’s public finances as more is eaten up in interest charges, leaving less for public services and stimulus. Effectively the presence of a large spread differential means that monetary policy is applied unevenly across the Euro Area, despite the "one size for all" objective of the ECB. And doubly so with a credit crunch which means some banks struggle to finance as a backdrop.

Japan Trapped On The Ropes

And as if all of this wasn't enough, Germany's main competitor in Asia (where German exports have been clocking up large increases) has been effectively KO'd by the flight to safety produced by the Sovereign Debt Crisis. Japan's exchange rate against the USD dollar is now hovering around a 15 year high.



The consequence of this is not hard to predict, while Germany clocks up record exports to China and other parts of the continent, the Japanese "recovery" is gradually grinding to a halt, as the latest manufacturing PMI report only confirms.




We Need To Seriously Address The Imbalances

At the end of the day it is hard to avoid the conclusion that we continue to live in a very unbalanced and essentially economically unstable world, where currency valuations and economic growth rates fluctuate with unnerving rapidity. Not only that, the recent Federal Reserve meeting seems to have constituted some sort of defining moment, the point when everyone finally recognises that the long promised recovery was no longer simply weeks or months away, and that emerging from the trough in which the developed economies find themselves is going to involve a long period of slow and painful effort, one where we will also need time to clean up the mess we have made in cleaning up the original mess, assuming that is that we have the dynamism and energy to do so.

On thing is clear, the old habits won't work any better now than they did before 2007, and external deficits which were not sustainable then will not be sustainable now. So we need a new model, a model in which the emerging markets will have a much larger role to play than ever before. And if we are to move towards a more sustainable future, then we need to move beyond those simplistic headlines stressing the virile nature of Germany's export prowess. There is no doubting the efficacy and competitiveness of many German companies, but for that very reason that country needs to shoulder more of the responsibility for sharing the burden which is involved in finding solutions. Here in Europe we don't only need sacrifices in the South, some of them also need to be made in the north. German industry is enjoying real and tangible benefits (via artificially low interest rates and an undervalued currency) from the mess that the Greeks created for themselves, but in the interest of all European some of those benefits need to be plowed back in again, since if Greece is allowed to fail, no one will be the winner.

Looking beyond Europe we need to think about how to best aid and abet the emerging economies in their quest for growth and better living standards. Earlier in the crisis I asked Nobel Economist Paul Krugman a question which is very much to the point. “At a time when the financial crisis is generalised across all developed economies - whether because those who borrowed the money now have difficulty paying back, or those who leant it now struggle to recover the money owed them - to which new planet are we all going to export?”

My response to him back in January was that maybe we don't need to look so far afield. Many developing economies badly need cheap and responsible credit lines, and access to state-of-the-art technologies, so why not accept the world is changing, and go for some sort of New Marshall Plan, one capable of generating a win-win dynamic which would be in all our interests? At the time the proposal seemed totally unrealistic and unobtainable. Now, with every day which passes it starts to look essential. And who knows, maybe the rise of a number of other major economic powers would help solve that bipolar currency problem which is currently causing our policymakers so many headaches.

One Swallow Doesn't Make A Summer, But....

Well, as we all well know one swallow doesn't make a summer, and one data point doesn't swing an argument one way or another, but the latest retail sales PMI reading for Germany is far from being either uninteresting, or (for my part) surprising. Basically after only two months (in the last twenty seven) of registering growth, the August PMI suggested that German retail sales once more fell back. And the anecdotal explanation for this: Spain's victory in the world cup affected the shoppers appetite! Actually, from a long term aggregate point of view I think (and economic study would be a waste of time if it weren't like this) that rather more factors come into play than football and the weather.

August data signalled a modest decline in month-on-month sales, reversing the solid upward trend registered in both June and July. At 48.4, down sharply from 57.2 in the previous month, the seasonally adjusted Retail PMI was below the 50.0 no-change value for the first time since May. The latest reading was the lowest for four months and slightly below the long-run series average (49.1). Anecdotal evidence suggested that less favourable weather conditions and reduced consumer footfall had negative impacts on like-for-like sales in August. Some retailers also noted that the end of the football World Cup had contributed to a decline in household spending.

Of course, the retail PMIs are not an exact science, and they only give us an indication of the retail environment. But their long term trend is not in disharmony with the actual sales data provided later by the statistics office, since sales in Germany have been generally trending down, and as the writers of the report say, the long-run series average (49.1) does show slight ongoing contraction .



Consumer confidence, on the other hand, has risen slightly in recent months, but it is still well below the pre-crisis level:




While the ZEW investor sentiment index - normally a forward looking indicator - has been dropping steadily for some months now.



So if we combine this with the August flash German PMI reading (which dropped back slightly over earlier months), it would seem that some easing off of German GDP is taking place, and indeed few will be surprised by this, since the very rapid rate of Q2 growth was clearly a one off. The issue really is that these very rapid (Leo Messi in-the-box type) accelerations don't seem to pass through to self-sustaining (via the consumption pillar) expansions, and I do wish more people would start to ask themselves why this is.



Moving on to other parts of the Euro Area, French retail sales seem to have continued to grow in August, although at a rather weaker pace than in July.



But whichever way you look at it French retails sales have a decidedly more positive look about them than their German equivalents.


What really seems striking to me is the difference in outlook being expressed by the retailers in the respective countries. According to the German report:

Although retailers were downbeat about their actual sales in August, latest data pointed to a surge in optimism about the prospects for sales in September. The degree of positive sentiment about the outlook for sales in one month’s time was the most marked since April 2008. Almost one-quarter of survey respondents anticipate sales to beat their initial forecasts. A number of retailers linked their optimism to improving conditions in the domestic economy.

On the other hand, the French report talks of caution among those interviewed:

The value of goods ordered by French retailers for resale decreased for a second straight month in August. Panellists indicated that they preferred to take a cautious approach to stock decisions at the present time. Correspondingly, inventories declined at the fastest rate since January.

One wonders what the basis for such expectations actually are. It couldn't possibly be that they are being influenced by the press and media coverage of the situation, could it, since in neither case do I see the expectations as especially realistic. The French seem to be too pessimistic, and the Germans way too optimistic.

Meanwhile over in Italy it was plus ça change, as retail sales continued their now customary decline (if at a rather weaker pace than in recent months), with the consequence that the Eurozone Retail Sales Index suggested that sales across the Euro Area fell very slightly in August (on aggregate).



Well, all meat for Monsieur Trichet to chew on before Thursday's meeting.