Thursday, August 04, 2011

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".

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