There is a saying about the Germans that they are either “himmelhochjauchzend or zu Tode betrübt” – either totally euphoric or depressed. Right now, the Germans are euphoric – at least about their economy, Financial Times columnist Wolfgang Münchau points out as German business confidence is approaching all-time high, reached in 1990 and 2007.
“We are heading away from himmelhochjauchzend to the other choice.”
The mood swing of German industrialists during the first half of this year is quite astonishing, Münchau notes and ask the obvious question: “What happened? And how should we read these data?”
Well, here’s his answer, published in today’s Financial Times Deutschland:
For a start, we should recall that the German economy contracted by 5% in 2009. Even 2.5% growth in 2010, and a hypothetically optimistic 2% growth rate in 2011, will only just get Germany back to the end-2007 of growth by end-2011.
What we have been seeing in Q1, Q2, and early Q3 is a fast recovery from a very low position after the 2009 slump.
Things are slowly returning to normal.
So when discussing the German economy, it is important to look at actual levels, not just at relative shifts. If you compare German and US real GDP, say over the last 10 years, the US is faring better both in terms of the total period, but, most importantly, also in terms of catch up to the pre-crisis level of real GDP.
The data, at least up until the first quarter, do not suggest that there is a particular German miracle.
All they show is a somewhat greater degree of volatility. Germany slumped faster than the others, and is recovering a little faster.
I expect Germany’s relative performance to be better this decade, by a little, not by a lot.
We should be clear about why this is likely to be the case. This has nothing to do with productivity enhancing reforms – or some underlying structural features of the German economy.
The main reason is the country’s success in depressing its real exchange rate.
Germany is now reaping the dual benefits of the depreciation of the real exchange rate inside the euro zone, and the nominal depreciation of the euro from the $1.40 plus level to the $1.20 plus level.
Can this be sustained?
Probably not. If the current developments persist, German companies are bound to hit capacity limits shortly, which will in turn put some pressure on the labor market. I have heard estimates according to which we may not be all that far away from that situation.
I would thus expect the Germans on the ECB’s governing council to press for a monetary exit relatively soon. They need higher interest rates to prevent German wages from rising.
If they succeed, Germany’s imbalanced growth strategy might continue for a little while, but this would clear come at the expense of any adjustment within the euro zone.
It really is a zero-sum game.
3 Arguments Against Recovery
I suspect that Spain and southern European countries may not be able to close the competitiveness gap with Germany quickly, but at the same time it is hard to conjecture that the gap might continue to rise further.
They are the decrepit state of the banking system, the global economy, and the self-imposed balanced budget rule. Overtly, the German banks did alright in the stress tests.
The results are not all that different than for the EU average. What the stress tests do not mention is an over-reliance on hybrid capital – which is at best only partially a risk-absorber in a crisis.
If you removed the hybrid capital, the German Landesbanken would be effectively insolvent.
The second factor is the global economy, on which Germany’s export model depends. Unless the upswing is sustained on a global level, Germany will not be able to maintain the most recent momentum.
And finally, the self-imposed constitutional fiscal rule will not have much impact in the short term, as the 2011 fiscal consolidation is relatively modest. But it is likely to be a constraint further down as we proceed through the economic cycle.
There is some cyclical leeway in the rules, but the average allowed deficit of 0.35% is extremely tight, and its legal force is significantly higher than previous soft-constrained budget rules.
Fiscal policy is likely to be a constraint on growth for some time.
A Ricardian Reality Show
The German official line is that the increase in public savings will be perfectly offset by a decrease in private sector savings.
They really do believe in all this Ricardian equivalence stuff, despite the fact that there is no empirical support in its favor.
In summary, Germany may still outperform southern Europe, but then so will almost everybody else.
With fiscal and monetary tightening ahead, less scope from windfall gains in the real exchange rate, and a persistently under-capitalized banking sector, it will be tough to maintain the most recent momentum.
In other words we are heading away from “himmelhochjauchzend” to the other choice.
By Wolfgang Münchau
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