FRANKFURT — Long one of the globe’s economic stars, Germany is on a brink of a reversal of fortune which some fear imperils the prosperity built by its post-war generation.
While on the surface, the German economic engine is purring, a recent reversal in exports and steep stock price falls betray deep-seated problems in the continent’s most populous and industrious country, a central pillar of the European Union.
In May, Europe’s biggest economy imported more than it exported for the first time in three decades, breaking a winning streak as “Exportweltmeister” or “global export champion” since the country’s reunification.
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Finance minister Christian Lindner compared it with a “profit warning” – a red alert companies issue if earnings are set to disappoint. Selling more than it buys has been a central tenet of Germany’s ascent to the global economic elite.(Graphic https://tmsnrt.rs/3nHJ7eX)
Just weeks earlier, on the same day as Berlin edged towards rationing energy, shares in Deutsche Bank and Commerzbank , the country’s flagship lenders and bellwethers for its economy, tumbled around 12%.
German regulators put that collapse down to fears for the country’s economy in the face of curbs in the supply of Russian gas that underpins industry, said one person with knowledge of the matter.
“This may really be the beginning of a weaker period for Germany,” said Achim Truger, one of the government’s chief economic experts that advises the chancellery.
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“If ever somebody viewed Germany as a role model, maybe it’s time to have a realistic view about strengths and weakness. Nobody’s perfect.”
After the World War Two, Germany, bolstered by U.S. aid, built its economy on cars, machinery and chemicals, controlled through banks such as Deutsche Bank owning stakes in industrial firms – a system known as Deutschland AG, or Germany Inc.
The country’s Bundesbank held its currency steady, cheap Russian gas powered industry and unions were tied into management boards to control wages. The result: an icon of industrialism grudgingly admired around the globe.
All this fueled leaps in exports through the 1980s, 1990s and 2000s, by which time the Deutsche mark had been replaced by the euro at a rate which made German exports attractive.
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Germany, thanks to labor market reforms, overcame a spell as the “sick man of Europe” at the turn of the millennium, but its success in selling more to its European neighbors than it bought, antagonized many countries that borrowed to buy German goods.
Then Berlin’s insistence in the debt crisis that countries such as Greece accept tough conditions for emergency loans fueled more resentment. But many Germans rejected such criticism, crediting their efficiency for the nation’s success.
Seeking to rekindle the collaborative spirit that led to this success, German Chancellor Olaf Scholz this week met trade union and employer association leaders to discuss what he called a “historic” cost of living crisis.
Scholz, a Social Democrat, said he was reviving a model of cooperation established in 1967 when Germany fell into recession for the first time since its post-war boom.
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But it will be harder now to placate trade unions, following a national drive to keep wages low through tax-free “mini-jobs” that capped hourly earnings for many low-skilled workers at about 10 euros – just enough to buy 20 McDonald’s chicken McNuggets.
Reforms to curb unemployment payouts, introduced by Social Democrat chancellor Gerhard Schroeder, who forged close ties with Russian president Vladimir Putin and later worked for a Russian oil giant, further soured relations with unions.
Although Germany appears more stable than Britain, which is facing government upheaval, or France, where people clad in yellow vests protested against soaring costs of living, tensions are simmering.
Growing worker discontent can be seen in the rise of strikes. Those peaked recently in 2015, with roughly 28 strike days per 1,000 workers compared with almost none in 2000, and more recently, unions have warned of more strikes to push for wage hikes.
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“I saw this risk … when there was discussion of a gas embargo,” said Monika Schnitzer, another economic adviser to the government. “I would be seriously worried about stability.”
SYMBOLIC SHIFT
Economists now believe that Germany could be opening a bleak chapter.
Although it held up better than the euro area as a whole during the pandemic in 2020, its economy did not rebound as strongly as the bloc in 2021 and is expected to lag this year.
The European Commission forecasts Germany to grow 1.6% this year compared with 3.1% for France and 4% of Spain.
“Globalization, just-in-time supply chains and cheap energy from Russia – those are things that are changing and they are changing for good,” said Carsten Brzeski, an economist with Dutch bank ING.
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Those advantages have helped make German industry, from giants to hundreds of medium-sized champions, so successful.
“This is a real turning point for Germany,” he said.
Germany’s critical engineering and machinery sector, which outfits factories throughout China and the world, is on edge.
Ralph Wiechers, executive board member at the industry’s VDMA trade body described the trade balance swinging into the red as a “warning.”
“The question now is to what extent customers worldwide will scale back projects,” he said.
Fielmann, the German eyewear manufacturer that operates in 16 countries, is pessimistic. Its shares have tumbled a third this year.
“We are feeling the considerable increase in transport and energy costs and the pressure in the supply chains,” said its chief executive Marc Fielmann.
Gunther Schnabl, an economist with Leipzig University, blames German penny pinching for the country’s predicament.
For years, Germany has saved money on defense and infrastructure while helping exporters by keeping wages low and importing cheap gas from Russia, he said.
“But it wasn’t investing the money. Instead it was using it to hide an erosion of prosperity. This isn’t going to work for much longer. Divisions and dissatisfaction are growing.”
(Writing By John O’Donnell Editing by Tomasz Janowski)
The world’s third largest economy recovered to its pre-pandemic size in the second quarter, as consumer spending picked up following the end of coronavirus curbs on businesses.
(Bloomberg) — The world’s third largest economy recovered to its pre-pandemic size in the second quarter, as consumer spending picked up following the end of coronavirus curbs on businesses.
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Gross domestic product grew at an annualized pace of 2.2% in the second quarter of this year, coming in below the median estimate of 2.6%, Cabinet Office data showed Monday. That lifted the size of the economy to 542.1 trillion yen ($4.1 trillion), above what it was at the end of 2019. First quarter GDP was revised to an expansion from a prior contraction.
“The economy managed to return to its pre-pandemic size, but its recovery pace has been slower than other nations,” said economist Takeshi Minami at Norinchukin Research Institute. “I expect growth to continue in the third quarter too, but it will likely be losing momentum down the road.”
The end of pandemic restrictions on businesses in late March helped spur the economy. Consumer spending, which accounts for more than half of Japan’s economic output, led the growth, as did capital expenditure. The relaxing of Covid rules resulted in increased spending at restaurants and hotels, as well as on clothes, according to the Cabinet Office.
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Still, the gains were more limited than expected a few months ago, showing that pent-up demand among consumers has been moderate.
What Bloomberg Economics Says…
“Going forward, we expect growth to slow in 3Q. Persistent cost-push inflation and a surge in new Covid-19 cases point to downside risks to the recovery. These will probably outweigh any boost from inventory rebuilding.”
— Yuki Masujima, economist
For the full report, click here.
While the economy regained its pre-pandemic size, economists expect the central bank to stick to its current easing policy, and the government to continue providing support for households hit by both the pandemic and rising prices. Other developed economies are doing the opposite by raising interest rates to cool demand and rampant inflation.
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Japan’s milestone also comes behind the US’s, which recovered its pre-pandemic economy size a year ago, while much of Europe regained it at the end of 2021.
The report came out as downside risks mount at home and abroad. Japan has been reporting record Covid infection cases with daily numbers continuing to top 200,000 this month. The government has so far kept economic activity as normal as possible without bringing back restrictions. But high-frequency data suggest people’s mobility is falling.
In Japan’s key trading partners, growth is slowing as the US and Europe fight inflation and China sticks to its zero-Covid policy. The war in Ukraine continues to disrupt food and energy supplies while the crisis in Taiwan is adding to geopolitical risks.
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Inflation remains relatively moderate in Japan, but consumption may cool with prices rising faster than wages. After factoring in inflation, paychecks in Japan have been falling for three months in a row through June.
Prime Minister Fumio Kishida reshuffled his cabinet last week but signaled that the core parts of his policies will remain the same. Kishida also suggested he’ll remain flexible on fiscal support, although he’ll focus on spending existing reserve funds first before reaching for additional debt issuance.
Japan Kishida Orders Continued Wheat Prices Cap, More Grants (1)
Kishida ordered Monday another set of measures to contain inflation by early September, with a boost in funding for regional governments and a continued cap on imported wheat prices. He emphasized that wage gains need to be sustained, while saying that the additional support measures will concentrate on food, regional grants and energy.
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For now, the measures will be supported by existing reserve funds, though Kishida said he’ll remain flexible in his approach.
“Inflation can cool consumption, although oil prices may stabilize with the global economy slowing down,” said Norinchukin’s Minami. “As downside risks mount in the world economy, there’s a risk that Japan’s economy could contract at some stage toward the end of the year.”
Bank of Japan Governor Haruhiko Kuroda has repeatedly said that the central bank must retain its easing program to support the economy until inflation becomes sustainable. He’s still seeking healthy wage gains, and price rises that go beyond a boom in commodities.
So far, economists expect growth in Japan to remain moderate for the rest of the year, slowing as the months progress. For the third quarter, analysts expect annualized gains of 3.2%.
(Updates with more details on additional price relief measures)
I don’t do a lot of these things because it’s just easier and more comfortable to talk about stuff on my podcast but this one sent me a great list of questions ahead of time that I liked.
Here are 6 of the best questions with some thoughts on each:
(1) What is your reaction to the latest CPI report and your outlook on inflation?
Inflation was basically flat from June to July.1
This is the first good news we’ve gotten on the price front in a while. You can see the energy components finally softened in a big way (via the BLS):
Inflation of 8.5% over the past 12 months is still uncomfortably high but it’s going to take a while for that rate to subside, even if prices do continue to slow in the months ahead.
Obviously, one data point does not make a trend but it does seem like the Fed’s moves along with some easing of supply chains have helped stop the uninterrupted rise in prices.
Gas prices are down like 60 days in a row. Oil prices are down. Used car prices are finally falling.
We can build on this (I hope).
(2) Where does the Fed go from here?
It’s difficult to know exactly what the Fed will do without knowing what the inflation data will look like in the coming months.
The labor market is certainly in a better place than it was in 2020 but inflation is running just a smidge higher than their 2% target.
Fed officials say they’re not done hiking rates just yet and I tend to believe them (for now):
Minneapolis Federal Reserve Bank President Neel Kashkari on Wednesday said he is sticking to his view that the U.S. central bank will need to raise its policy rate another 1.5 percentage points this year and more in 2023, even if that causes a recession.
The Fed is “far, far away from declaring victory” on inflation, Kashkari said at the Aspen Ideas Conference, despite the “welcome” news in the consumer price index report earlier in the day that inflation may have begun to cool.
Kashkari said he hasn’t “seen anything that changes” the need to raise the Fed’s policy rate to 3.9% by year-end and to 4.4% by the end of 2023. The rate is currently in the 2.25%-2.5% range.
The Fed waited too long to act and they don’t want to look like idiots again.
They care more about inflation than the job market right now so they’ll likely keep raising rates until we get a number of lower inflation prints.
If they go too far that has to be a risk to both the stock market and the economy.
(3) What does a soft landing look like?
Let’s start with what a hard landing looks like and work backwards.
The average increase is more than a doubling off the lows. That would take us to more than 7% from the current 3.5% unemployment rate.
To me, a soft landing would see inflation below 4% or so without a commensurate rise in the unemployment rate. The lowest it’s ever increased to during past slowdowns is just over 6%.
I’d say anything 5% and under for the unemployment rate would be a win if we could get inflation back to 3% or so.
What’s the scenario that could make this happen?
The labor market is in a weird place right now since there are more jobs available than people who are looking for one:
Those openings have come down a bit from 11.7 million to 10.7 million. The dream soft landing scenario for the Fed would see these openings fall by 4-5 million but the unemployment rate doesn’t go much above 4-5%.
Is this actually possible?
History says no but employers have been dealing with a challenging hiring market since the start of the pandemic.
Sam Ro wrote a thought-provoking piece this week about the concept of labor hoarding that’s worth considering:
So what explains the current reluctance to shed workers?
Maybe recent experience has something to do with it.
Much of the ongoing economic recovery has come with persistent labor shortages. Employers haven’t been able to hire fast enough to keep up with the booming demand for their goods and services.
At least some of the employers seeing business slow right now remember how hard it was to recruit talent over the past two years and would rather just hang on to employees, even if it comes with carrying costs.
As a matter of convenience, of course it’s easier to just hang on to workers during a slowdown or recession if you expect the downturn to be brief and shallow.
Millions of people were either let go or put on the shelf in 2020 and that made it more difficult to re-staff once demand came back faster than companies are used to.
What if employers hold onto more employees than in past recessions if they assume the next one will be mild?
What if companies don’t want to go through the hiring process all over again following a recession?
That’s probably the best-case scenario for a soft landing if the Fed does cause a meaningful downturn in economic activity to get inflation under control.
(4) What is your general outlook on the markets and/or a recession?
I wish I had a good answer for this one. I don’t.
We could go into a recession while the stock market hits all-time highs.
Or we could see the stock market tank even if the economy improves from here.
Sometimes these things don’t make sense.
My macro outlook has never really helped my portfolio all that much.
Sometimes my thoughts on the economy/markets would have served me well. Other times my thoughts on the economy/markets would have destroyed my portfolio.
Here’s a little secret about investing the pros will never admit — you don’t have to predict the future to be successful in the markets.
Outlooks are more helpful for your ego than your performance in most cases as long as you have a reasonable investment plan in place.
(5) What can we learn from this downturn?
Since the start of 2020, the U.S. stock market has fallen 34%, risen 120%, declined 24% and now gained almost 17%.
In less than 3 years, it’s felt like we’ve lived through every cycle imaginable — 1918, 1929, 1999, the 1970s, maybe the 1960s and some other parallel I’m probably missing.
Everything in the markets is cyclical.
Stuff that has never happened before happens all the time.
The biggest risks are always the things you’re not thinking about or preparing for.
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