German Exports and that Looming Double Dip

I hadn't seen an advance release of the January German export data, when I wrote the following on Tuesday, honest injun I hadn't:

Well, this is only a hypothesis. But if the hypothesis has any validity we should be able to make some predictions on the basis of it. I would make two. Firstly, since East Europe’s economies are often dependent for their growth on exports to the West, and in particular to Germany, then we should be able to see some “shadow” of this German process cast out into the East.

In the second place, we should see the process continue to some extent in Q1 2010. That is, based on what we have seen so far, in Q1 imports should rise, as industrial output in the early parts of the supply chain surges, and net trade should as a consequence be less positive than in Q4 2009. On the other hand, all the imported components awaiting processing should make inventories rise. So that’s a prediction. Now we need to wait and see how good it is.

I think I oulined in the post itself just how much you could see the impact of the long Eastward shadow cast by the German economy in the industrial output performance in Central Europe, but little did I expect, when I wrote those words that further confirmation of the hypothesis would come within a mere 24 hours:

Germany's exports unexpectedly declined in January compared to the previous month, official data showed on Wednesday, highlighting risks of a bumpy recovery in Europe's largest economy.Exports, adjusted for seasonal and calendar effects, dropped 6.3% in January compared to December 2009, the Federal Statistical Office, or Destatis, reported.

Most analysts expected a 0.5% increase in exports, which posted a monthly rise of 3.4% in December. Imports posted a monthly rise of 6% in January after gaining 5% in the previous month..

So we are seeing the imports rising effect, which suggests, since domestic consumption is falling at this point, that those inventories are starting to rise again, given that the expected follow through on exports is nothing like as dynamic as most analysts are suggesting. Oh, I know, I know, we have been having some very bad weather of late...

Axel Weber is forecasting a slight negative performance of the German economy in the first quarter, but in fact things are still not so clear since, as I wrote on Tuesday:

"Given everything I have said above about swings in imports and inventories, I would say German GDP will be very near to stationary again this quarter, with a possible slight upside depending on the inventory swing, but whatever upside we do see will more than likely disappear as quickly as it came when we get to the Q2 2010 data."

In other words, it is all down to inventories again, and these are very difficult to foresee. Nonetheless I would make two more points:

Firstly, the Bundesbank’s forecast for growth of 1.6 percent in 2010 is looking rather optimistic at this point, even though GDP was at a very low level last year, so in theory getting some growth should not be that hard.

And secondly, that German recessionary "double dip" that I mentioned back in November does not look so implausible at all at this point. All that is needed is a very slight downward revision to the Q4 2009 data, and Axel Weber's own prediction for very slight negative growth in this quarter to be confirmed, and there we will be, back in recession. Which would only leave us with the French economy - among the EU majors - showing any sign of a robust recovery.

Of course the implications of all this rather technical argumentation are fairly profound. In the first place, as I noted in this post, any talk of the ECB raising interest rates either this year, or in the first half of 2011, would seem to be way, way too premature. And secondly, it is becoming increasingly obvious that Europe's (theoretically) stronger economies are inexorably yoked together with all those supposedly weaker ones, via the Eurozone (and EU27) current account imbalances.



So solving one problem also implies solving the other. Never has the case for a "united we stand, divided we fall" approach been clearer. So gentlemen, please, let's get a note of reality back into all those deliberations about what to do with the problems being faced in countries like Latvia, Hungary, Greece and Spain. We need common solutions to common problems, and we need solutions that work.

The German Economy Is Essentially "Intact"

According to Bundesbank President Axel Weber, Germany’s economic recovery is “essentially intact”, and is now set to benefit from stronger demand in countries outside the euro region.

“I firmly believe that the recovery process that began in summer 2009 is essentially intact, and that it will continue despite the slower growth dynamic in the winter semester. An additional factor in this context is that the German labor market continues to be in extremely robust shape.”

What exactly it means to say that an economy is intact we will explore below, but it is clear that some confirmation for the view that the German economy is benefiting from increased demand originating outside the Eurozone can be found in the latest press release on manufacturing industry turnover from the Federal Statistics Office, where they note that while January's manufacturing sector turnover surpassed that of January 2009 – by a working day adjusted 2.6% - domestic sales actually fell (by 1.1%), and export turnover rose by 7.3%. Most interestingly, as between destinations, sales to euro area countries only increased by 2.4%, while those to other foreign countries were up 12.0%. This illustrates two points: that the German economy is now more dependent than ever on exports, and that sales to emerging markets are what is really driving export growth at this point. This latter development is hardly surprising given the strong fiscal corrections being applied in many of Germany's former customer countries.

German GDP "Probably" Stagnated In The Fourth Quarter of 2009

Whoever said economists are people who don't ever get anything right?

"Economic growth in Germany probably stagnated in the fourth quarter from the previous three months, the Federal Statistics office said. Still, the figure is “surrounded by uncertainty,” Norbert Raeth, an economist at the office, said in a press conference in Wiesbaden today."

So German GDP was probably more or less flat quarter on quarter between October and December. The figure is surrounded by uncertainty, as I pointed out in this post (Is There A Double Dip Risk In Germany? ), quite simply because German growth numbers at the moment are all about net trade and inventories, with domestic consumption in an entirely secondary role, and imports rebounded in the third quarter, which means the trade impact may at best be neutral, while inventories were probably run down (the extent to which this has taken place is what most of the uncertainty is likely to be about). As I started to point out back in mid November:

The question in hand is the Eurozone third quarter growth one, and the story is all about differences (between countries) and these differences in the key cases (France and Germany) are in many ways all about inventories……Now if you look at the chart below, you will see that German growth was in the second quarter was, more than anything, a statistical quirk which resulted from a balancing act between strong swings in inventories and in net trade. In the third quarter, as far as we can see (since we don’t have that ever so important detailed breakdown), this position has quite literally been inverted, as the earlier trade bonus has been eaten away by growth in imports....

That was before we got the detailed breakdown of Q3 growth. On November 28, following the publication of this data, I went on to argue that:

While a positive contribution to growth was made by goods exports, which were up 4.9% on the previous quarter, imports also rose , and by more than exports (up by 6.5%), and the resulting trade balance had a negative effect on growth of –0.5 percentage points. This was more or less the same as the contribution from household consumption (which was also negative by 0.5 percentage points). But what really, really mattered here - see the chart below - was the inventory build-up which added a staggering 1.5 percentage points to growth., while government final consumption expenditure only increased slightly (+0.1%) over the period and effectively had zero impact on the growth number. So, as I said, it is all about inventories in Q3.

Which lead me to conclude that:

In Q4 it is all going to be about trade. Since if German exports hold up, then the run down in inventories need not be that strong, but if exports don’t sustain momentum in December - and what just happened in Dubai is making me very nervous on that front - then German GDP will almost certainly fall back into negative territory in the fourth quarter. On the other hand, if I am jumping the gun slightly here, and German economic activity does manage to eke out some small increase at the end of the year, then I think a return to negative growth in the first quarter of 2010 is almost guaranteed. That is to say, we have a double dip on the horizon. At least, that is my call. Now it is over to you.

Well, my instincts seem to have been more or less good ones, and just to show that my forecast was not simply a fluke (ie that it is backed by some sort of coherent analysis, one that is testable), I would also draw attention to my "twin" post on Japan - Double Dip Alert In Japan, dated 7 December - where I said:

"Despite recent optimism about the apparent renaisance of growth in the Japanese economy, and the heightened sense of enthusiasm which surrounds the surge in economic activity right across the Asian continent there are considerable grounds for caution about the sustainability of the Japanese recovery itself".

Just two days laters Japan's third quarter results were revised down, sharply (and for most analysts unexpectedly sharply).

JAPAN'S economy grew much less in the third quarter than initially reported, revised government data showed today, as a strong yen and deflation weighed on economic activity by prompting firms to hold off on new investments. The new data revealed that July-September's real gross domestic product grew 0.3 per cent compared with the previous quarter, much slower than the 1.2 per cent expansion reported last month, and worse than analysts' consensus forecast of a 0.6 per cent rise.

So what's the point of all this? Well certainly not to say simply "aren't I clever now". The issues is that (for demographic reasons) the German and Japanese economies are totally export dependent, and thus it is unrealistic to expect the global recovery to be lead by an expansion in these economies. The recovery will have to come elsewhere (in France, for a start, but with France alone there is not enough) and the export dependent economies can then "couple" to that dynamic. It is difficult to say whether or not the Japanese economy will show some marginal growth in the fourth quarter, since the Q3 revisions make for a much lower base, industrial output has risen considerably on the quarter, but the important services sector has been contracting.

Essentially, until those heavily indebted economies (the US, the UK, Spain, Ireland, Eastern Europe, etc) who formerly ran current account deficits can find a way back to sustainable growth without the aid of large government stimulus programmes, any general recovery will remain extremely weak. And the German result has, of course, implications for four quarter Eurozone growth. As I said in this earlier summary of the Q3 eurozone performance:

So, going back to my original question, is this a whimper recovery, or are we on the verge of a double dip? I think, basically, it is all down to Germany, and those inventories. If external demand weakens in key customer countries then Germany will fall back into negative growth, and with it the whole "eurozone sixteen economy". Since demand in the South and the East of Europe is hardly going to be strong, given the new found need of countries in those regions to run trade surpluses, my inkling is that just this outcome is now a clear possibilty. So while the consensus at the moment seems to be that France disappoints, my view is that it is the German economy we really should be worrying about.