economy germany

Germany’s Obsession With ‘Black Zero’ Fiscal Policy Now Borders On Psychosis

There has to be a pain threshold.

“The gross domestic product did not continue to rise in the fourth quarter of 2019”, a clumsy translation of the German statistical office’s preliminary read on Q4 GDP reads.

Recapping a year to forget, Statistischen Bundesamtes writes that “after a dynamic start in the first quarter and a decline in the second quarter there had been a slight recovery in the third quarter of the year”. “Had” – past tense.

The economy stagnated in the fourth quarter, a result which, officially, was worse than expectations (consensus expected Germany to eke out a 0.1% expansion). Really, though, it wouldn’t be accurate to describe this as “below expectations”. The range was -0.3% to 0.2% and, at least anecdotally, traders would have been surprised to see a positive number.

Last week, Germany turned in some of the worst data on factory orders and industrial production imaginable, and that’s not me trafficking in hyperbole. Factory orders plunged a ghastly 8.7% on year during the final month of 2019, the worst showing in a decade. The next day, the country said industrial production crashed 6.8% YoY in December, nearly double the expected decline.

Admittedly, I’ve run fresh out of patience with this debacle. Germany runs a surplus. And here, for anyone somehow unaware, are Germany’s borrowing costs out to 30 years:

That Berlin refuses to loosen the purse strings to mitigate the worst factory slump in recent memory for an economy that leans heavily on manufacturing is ludicrous. It borders on pathological, in my judgement.

(Deutsche Bank)

In an expansive new take on the outlook, Deutsche Bank makes a number of observations that are well worth considering.

Among other things, the bank warns that the “Phase One” trade deal between the US and China could end up denting demand for German exports.

“One explanation why German exporters have provided more cautious answers in the ifo survey might be that it has begun to dawn on [them] that the Phase 1 deal between the US and China, albeit decreasing trade policy uncertainty, will divert demand from their Chinese costumers to US competitors”, the bank says, adding that “model simulations by the ifW research institute show that EU exports to China will be around USD 10.8bn lower in 2021, with the bulk hitting manufacturing [and] Germany and France suffering the biggest losses”.

And then there’s the coronavirus. Over the past couple of weeks, bank after bank has warned that if the outbreak undercuts the nascent bounce in the Chinese economy (and that is a foregone conclusion at this point), Germany will suffer.

Consider the following excerpt from Deutsche’s analysis (I would quickly note that although this passage seems long, it actually represents a tiny, tiny fraction of the study, which is in excess of 44 pages):

The deceleration of Chinese growth during 2019 clearly showed up in German exports. After expanding by 8.6% (goods, nom) in 2018 the growth rate slowed to 2.4% in the first eleven months of 2019, with the 3M average yoy rate being negative since August. With the Chinese economy expected to bottom out at the turn of the year, the auto industry, in particular, was hoping for some improvement in Chinese demand as it expected some pent-up demand to materialise. Sector experts estimate that some 35% of German OEM’s global turnover is generated in China (German OEMs have no major production sites in the Hubei Province). If, as we expect, the coronavirus will reach its peak pretty soon, demand might just be shifted further back into 2020. Still, in H1 a negative impact seems to likely. Due to the above-average margins enjoyed in China, even a temporary setback will feed through via the profit channel and make corporates even more cautious. Of course the virus will also make itself felt on the supply side. There are already some reports that supply chain problems are starting to show up in Korea. Other sectors such as electrical engineering, where China is the largest export market, are also concerned, especially as their exports to China expanded by a rather disappointing 4% in 2019. The German ifo institute calculates – based on the experience of the SARS pandemic – that a 1 percentage point lower annual GDP growth in China would shave off only some 0.06pp of German growth. However the authors warn that already the number of infected people now is larger than during SARS. Given the measures to contain it, the economic impact has probably exceeded SARS too. Also, in 2003 there was no real evidence that supply chains were affected, which could become a factor soon (shipping from China to northern Europe takes roughly 4 weeks).

What you can hopefully glean from that relatively short passage is that the transmission channels (and there’s a virus pun in there) from a sharp slowdown in the Chinese economy to Germany are myriad.

One of the points I’ve been keen to drive home lately is that the coronavirus outbreak has essentially replaced the trade war when it comes to imperiling global growth. It’s a “just when you thought it was safe” type of thing.

Whatever inflection you had baked in on the back of the Sino-US trade pact is now in question given that the virus threatens to exert a similar demand shock as that posed by an all-out, multi-sided trade conflict.

That means everything folks were concerned about during the worst of the US-China trade spat is now back on the risk radar, whether it’s demand destruction in commodities or disruptions to global supply chains.

Germany simply cannot afford another year of this. But what they can afford is to offset it with fiscal stimulus, and in doing so, Berlin could also deliver a confidence boost to the rest of the world, which may very well create a virtuous loop.

That’s an admittedly simplistic assessment and the situation is now more complex due to  political turmoil in connection with Annegret Kramp-Karrenbauer’s highly unfortunate fall from grace. But readers get the idea: There has to be a pain threshold for Germany when it comes to prioritizing fiscal discipline over economic despair. Maybe Germany just hasn’t reached that threshold yet, but what I would gently suggest is that by the time they do, it might be too late.

Why not get out ahead of things?


 

2 comments on “Germany’s Obsession With ‘Black Zero’ Fiscal Policy Now Borders On Psychosis

  1. Forgive me in advance for this novice question: Do the Germans adhere to this strict fiscal discipline in order to “lead by example” and wag their finger at the other EU countries (like Italy and Spain) where fiscal budgets are a mess?

    • I think Germany, better than perhaps any country, understands the devastating consequences of fiscal irresponsibility.

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