‘A Tragic But Important Lesson’: In Germany, Fear Of Deficit Demon Collides With Recession Reality

“[It’s] certainly very welcome”, Christine Lagarde said in Wiesbaden, commenting on news that Germany may be set to temporarily suspend its constitutional debt brake amid an extremely vexing manufacturing slump and, now, a burgeoning pandemic that threatens to make a bad situation worse.

“I don’t know enough about the overall project that has been briefly mentioned and announced, but I would say that any fiscal measures intended to support the economy are certainly very welcome, particularly under present circumstances”, Lagarde continued.

It was probably all she could do to keep from exclaiming: “It’s about time!”

Who knows if the plan – being pondered by Finance Minister Olaf Scholz – will be embraced beyond the SPD.

“The initiative… would shift borrowings from municipalities to the federal government, giving them more budget space to invest locally”, Bloomberg reports. “A lobby group for local authorities said the cost could exceed more than 10 billion euros ($10.9 billion)”.

The CDU will almost surely oppose it. It would need a two-thirds majority in parliament.

Pressure on Germany has mounted over the past year for obvious reasons. The world’s fourth-largest economy logged the slowest pace of growth in six years in 2019, and only managed to dodge a recession by employing a Matrix-style, bullet-dodging, backbend.

The country’s factory slump is heinous – and this is one time when “heinous” is a wholly inadequate adjective when it comes to conveying the scope of the malaise.

Factory orders plunged a ghastly 8.7% on year during the final month of 2019, the worst showing in a decade. Industrial production crashed 6.8% YoY in December, nearly double the expected decline.

Earlier this month, I called Berlin’s steadfast refusal to loosen the purse strings to mitigate the pain “ludicrous” and borderline “pathological”, considering the country’s large (and persistent) surplus.

(Deutsche Bank)

European officials – and not just at the ECB – are becoming increasingly exasperated with the Germans. The European Commission on Wednesday chided Berlin for jeopardizing not just its own growth, but that of the entire euro-area. (And if you’re inclined to think the EU is destined to fail anyway, then you can just flip that around. That is, you could change the thrust of it by saying the European Commission chided Berlin for jeopardizing not just euro-area growth, but the economic fortunes of the country’s own citizens.)

“The subdued net investment share of GDP continues to put at risk Germany’s future growth potential, and has implications for the euro-area”, the commission charged, in a new report. “Higher public investment would generate positive domestic and cross-border spillovers… boost[ing] output and employment in both Germany and the rest of the euro-area”.

As Bloomberg reminds you, “Germany stands out as the only Group of Seven member with a budget surplus, and a relatively low debt burden”. Germany’s entire curve went negative again this week, when 30-year yields fell below zero for the first time since October.

Earlier this month, I talked a bit about the rather obvious spillover effects the coronavirus outbreak will have on the already fragile German economy. If anything, those spillover effects are expected to be worse now.

I also said Germany cannot afford another year like 2019, but what they can afford is to offset it with fiscal stimulus. In doing so, Berlin could deliver a confidence boost to the rest of the world, which may very well create a virtuous loop.

Finally, in a rare moment of humility, I called my take “an admittedly simplistic assessment” and noted that the situation had been made more complex due to political turmoil in connection with Annegret Kramp-Karrenbauer’s highly unfortunate fall from grace.

But, according to some who are better connected in fiscal policy circles than I am, there is some political will – it’s just that years of deficit fearmongering has left politicians trapped.

“I know from recent conversations, including with some in the Ministry of Finance, that they feel boxed in by their own communication strategy around ‘black zero'”, Stephanie Kelton said, earlier this month, adding the following:

Many readily admit the need for fiscal easing, but they worry about “failing” to deliver on fiscal target. They use some off-balance sheet maneuvers to provide some fiscal support, but they know that much more is needed. The problem is that they created a monster–literally erecting monuments to honor the zeroing out of deficits. So, the public believes budget outcomes are paramount.

It’s possible that Germany’s fiscal situation will deteriorate anyway over time. For example, Deutsche Bank notes that “while the government continues to benefit from lower interest spending, there is likely to be a slowdown in revenue growth due to the slump in economic development”.

In an expansive take on the German economy out earlier this month, the bank went on to say that “given the continued high growth of primary government spending (welfare services, investments) and moderate tax relief (e.g. partial abolition of the solidarity surcharge from 2021), we are likely to see some rapid fiscal deterioration from a structural perspective”.

(Deutsche Bank)

Indeed, Deutsche expects the general government’s structural primary balance “to decline by 0.8% of GDP in 2020 and 0.5% of GDP in 2021”. Ultimately, the bank says the government’s surplus will “finally disappear entirely by 2021”.

That’s a small taste of the nuance, and, as with any large economy, you can dive as far into the weeds as you like when it comes to parsing the numbers and making projections.

But right now, the bottom line is that the German economy remains on the brink of recession. And, all else equal, the COVID-19 outbreak will surely make things more challenging, especially now that Italy is the second-largest virus cluster outside of South Korea. (That very well may presage more infections across the euro-area, and France has already said they’re prepared for just such an outcome.)

So, fingers crossed on Scholz somehow being able to push whatever it is he’s planning past the hawks (and there are a lot of them in Germany). As alluded to above, and as captured in Lagarde’s cautious tone, market participants are likely to remain skeptical.

“Many government officials feel trapped by their own campaign to entrench fiscal targets [and] a fear of deficits in the minds of the German people”, Kelton went on to say a few weeks back, noting that there’s “a tragic (but important) lesson here”.


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One thought on “‘A Tragic But Important Lesson’: In Germany, Fear Of Deficit Demon Collides With Recession Reality

  1. And if the Germans think the landscape is ugly now, just wait until the US Consumer crumbles as a result of the virus-induced contraction. Look our below…

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