The German ship is sinking under the weight of its own delusions

Eurostat’s recent publication (October 14, 2014) – Industrial production down by 1.8% in euro area – rightfully sends further alarm bells throughout policy makers in Europe, except I suppose Germany where denial seems to be rising as its industrial production levels fall to performance levels that the UK Guardian article (October 9, 2014) – Five charts that show Germany is heading into recession – described as being “shockingly poor”. The Eurostat data shows that industrial production fell by a 4.3 per cent – a very sharp dip in historical context for one month. Vladmimir Putin and ISIL are being blamed among other rather more oblique possible causes. But the reality is clear – the strongest economy in the Eurozone is now faltering under its own policy failures. Eurostat tell us that:

In August 2014 compared with July 2014, seasonally adjusted industrial production fell by 1.8% in the euro area (EA18) and by 1.4% in the EU28 … In August 2014 compared with August 2013, industrial production decreased by 1.9% in the euro area and by 0.8% in the EU28.

Industrial production is in the Eurozone is still 13.1 per cent below the April 2008 peak and only 3 per cent higher than when the common currency came into being in 2000.

So essentially, after some growth in scale leading up to the GFC, the crisis has wiped out all those gains and the current bias is towards a further decline in industrial production.

The policy makers thus should explain why the monetary system is being retained that has failed to deliver any gains in 14 years in output.

The following graphs show the industrial production indexes (100 = January 2000) for Germany first and then Germany, France, Italy, Spain and Greece second.

Germany’s industrial output is back at December 2006 levels – in other words, the GFC and ensuring policy mistakes (austerity) have seen the economy essentially stuck in a stagnant state for 8 years.

When we add the other nations, we see how devastating the GFC and resulting fiscal austerity has been. Industrial production in the other two main economies of Europe (France and Italy) continues to fall.

For Spain the economy is stuck and Greece continues to exhibit basket case data.

The percentage decline since the April 2008 peak in industrial production is 5.8 per cent for Germany, 16.4 per cent for France, 25 per cent for Italy, 30.7 per cent for Greece and 27.7 per cent for Spain.

That is a lot of productive capacity to have been left underutilised and a massive amount of real income sacrificed.

I defy anyone to demonstrate how breaking up the Eurozone in 2008 and abandoning the fiscal constraints embedded int eh Stability and Growth Pact would not have produced a better result than this.

Of course, if the ECB had have stepped in at the outset of the crisis and told the Member States that they would guarantee all fiscal deficits (through secondary bond market purchases if necessary) and the European Council had have relaxed the SGP provisions (by invoking the emergency provisions), no treaty change would have been required and the crisis would have been resolved.

But then under those circumstances the nations may have abandoned the euro and returned to their own currencies, notwithstanding the cross-border convenience of the common currency. Many people think the ‘efficiencies’ (translated into lower costs) of the common currency for cross border trade are large. The reality is different as I explain in my Euro book, which will emerge in in published form in early 2015.

A related problem facing Germany is that its growth engine has stalled dramatically. As the UK Guardian notes:

German exports fell by 5.8% in August. It was the biggest drop since the early stage of the financial crisis in January 2009. Imports also shrank, by 1.3% …

When you see exports and imports dropping you can safely conclude that there is a major aggregate spending and income decline – externally, which undermines export sales, and, domestically, which leads to less imports.

A bad conjunction.

Further evidence that the Eurozone is heading for a triple-dip recession comes from the Tuesday release of the – ZEW Economic Sentiment Index – is a leading indicator for the German economy.

A leading indicator tells us what is likely to happen in relation to real GDP movements, whereas a lagged indicator follows swings in real GDP (peaks troughs etc).

The ZEW Indicator of Economic Sentiment is a monthly series and you interpret it in this way:

The ZEW Indicator of Economic Sentiment is calculated from the results of the ZEW Financial Market Survey. It is constructed as the difference between the percentage share of analysts that are optimistic and the share of analysts that are pessimistic for the German economy in six months. Example: If 30 per cent of participants expect the German economic situation to improve within the next six months, 30 per cent expect no change and 40 per cent expect the economic situation to deteriorate, the ZEW Indicator of Economic Sentiment would take a value of -10. Thus, a positive number means that the share of optimists outweighs the share of pessimists and vice versa.

Here is a graph of the Indicator since its inception in December 1991. The green line indicates the average value of the entire series, and thus the current value of -3.6 is not only well below the average but also across the zero line indicating majority pessimism.

The ZEW press release also tells us that:

The ZEW Indicator of Economic Sentiment for the Eurozone decreased in October as well. The respective indicator has declined by 10.1 points compared to the previous month, reaching 4.1 points. The indicator for the current economic situation in the euro area has decreased by 13.0 points to a value of minus 56.8 points.

So the malaise is broad as is to be expected given the conduct of fiscal policy and the ineffectiveness of monetary policy in the Eurozone.

In the context of Germany’s pledge to balance the fiscal outcome in 2015 and stop issuing new debt from that point (recall their constitutional change in 2009), the German Economy Minister Sigmar Gabriel continued to deny the obvious.

He was quoted in the UK Guardian article (October 15, 2014) – Fears of triple-dip eurozone recession as Germany cuts growth forecasts – as saying:

There is no reason to abandon or change our economic or fiscal policy. Increasing debt in Germany will not generate additional growth in Italy, Spain, France and Greece.

Which is a devious evasion of the reality. The correct statement is that – increasing the fiscal deficit in Germany (from its current surplus) will definitely generate additional growth in Italy, Spain, France and Greece and more nations beyond.

Such are the close intra-Eurozone trade linkages that a stimulus to German imports relative to exports would certainly stimulate spending elsewhere in Europe.

The fact that Germany would have to issue more debt to run a relatively large fiscal deficit given current institutional arrangements means that the Finance Minister’s claim are also wrong.

But it would be the increased net spending that generated the growth not the sale of more public debt.

To emphasise the need further, we only have to consult the current inflation figures for Europe. In Spain, for example, the Consumer Price Index fell for the third consecutive month. In general, inflation is very low and biased towards declining further.

There is an interesting book that has just come out – The Germany Illusion – by Marcel Fratzscher, who is the director of the German Institute for Economic Research (DIW).

He believes that German policy makers are guilty of hubris when talking up the performance of the German economy. The reality is that:

1. The jobs miracle is nothing of the sort – lot of part-time, precarious jobs (the ‘mini-jobs’).

2. Exports have been made competitive by suppressing real wages in Germany rather than expanding productivity. The latter approach is the only lasting way to rising living standards.

3. Most of German non-traded industry is chronically unproductive.

4. Since 2005, total hours worked have been virtually unchanged.

5. Investment in productive public infrastructure is among the lowest in Europe (well below the EU27 average.

This has led to three illusions (although it would be better to call them delusions):

1. That German is pursuing the correct policy approach to achieve sustained growth indefinitely – balanced budget, real wage suppression, export focused.

2. That Germany could achieve this growth without the Eurozone, so is effectively doing the other nations are favour by sharing their largesse.

3. Related to 2, that Germany is the only thing holding the Eurozone together and its taxpayers are funding the bailouts of the profligate Member States elsewhere.

None of these three, commonly held propositions in Germany, are valid according to the book.

He writes that Germans save a lot but fail to invest it in domestic infrastructure. Rather, they chase lower returns elsewhere in Europe which not only reduces the imports that Germans might enjoy but also reduces productivity growth and generates the external deficits in other European countries.

All of which amplifies the vulnerability that the overall Eurozone has to aggregate spending collapses such that we saw in 2008 and extends any resulting crisis.

Conclusion

Nothing much has changed since I wrote this blog – The German model is not workable for the Eurozone – on February 3, 2012.

Nothing much will change until the policy elites accept the failures of the past and dramatically change direction. But apart from the periods of World War in Europe, there hasn’t been much evidence of such reversals.

It is going to be a slow-burn unless the anti-euro activists in Italy and France become better organised. The problem is most of the activists that I am aware off want to keep the euro!

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.