Germany's dark future

Inflation is falling fast in Germany. Today's figures show a fall in annualised CPI growth to 0.7%. And this is in the supposedly powerful core of the Eurozone. Out in the periphery, things are much worse.

But whereas disinflation or even outright deflation in periphery countries has little effect on Eurozone aggregate inflation, German disinflation is an entirely different matter. Thomson Reuters has helpfully produced a chart showing the relationship between German and Eurozone inflation:

Nicely correlated. In fact it is so well correlated that it is probably fair to say that ECB monetary policy is really determined by inflation expectations in Germany.

In the last year there has been some divergence because of the awful performance of Spain and Italy and the stagnation of France, which has led the ECB to attempt to introduce a credit easing programme against the wishes not only of the Bundesbank, but of German politicians. But although disinflation in Germany doesn't seem worry its politicians or its central bankers despite the consequences for the rest of the Eurozone, the threat of recession should:

Germany's exports to Russia have collapsed due to sanctions. This may of course only be a temporary problem: the German export machine is not going to be derailed by a few Russian difficulties. A much bigger problem is the slowdown in China, to which Germany is a major exporter of intermediate goods. Whatever the cause, Germany's exports have suffered a substantial drop:

More worryingly, industrial production figures for August showed a fall of 4%:

And factory orders fell off a cliff:

Ouch. No wonder investor confidence is falling:

But this is very bad news for a country where investment is already shockingly low and government is ideologically averse to spending money. The IMF's call for Germany to invest should be seen in the light of these awful figures. The wheels are coming off Germany's export-led, demand-deficient economy - and that is very bad news not only for Germany, but for Europe and indeed for the world.

The ECB has been accused of putting the interests of "profligate periphery countries" ahead of prudent German savers. But in fact it is trying to reflate the German economy through monetary stimulus. It is utter madness for German politicians and Bundesbankers to oppose this. They should back off and let the ECB do its job.

But it will take more than credit easing to sort out this mess. Germany desperately needs a change of stance from its fiscal authorities, too. Unless it invests in its own future, dark days lie ahead.

Related reading:

Should the UK be more like Germany? - Pieria
Fear the fear


  1. This is a terrific article that really puts thing in focus. Thank you. A couple of things strike me. One, Germany has a perennial problem; in fact a problem that probably cost it two World Wars. Germany is an industrial economy in a resource poor country. Apart from some very low-grade coal and some potash, Germany has few resources of its own.

    This makes trade not a choice, but an existential necessity. To support its population, Germany has to be a country that imports raw materials, transforms them, and exports the resulting products. At its current population level, this is really the only way Germany can function.

    But, just as in the Great Depression, if Germany depends too much on trade it is that much more exposed to international instability, and especially to the kinds of instability that lead to declines in international trade. Hence the negative importance of sanctions against Russia.

    But if reliance on trade is an economic essential, then the necessity to preserve trade becomes a political imperative. We saw this also during the Thirties, when Germany first set up a semi-alliance with the USSR and then decided to go for broke and try to seize control of the USSR's land and resources. I guess we can safely say that today the latter strategy is off the table, leaving only the first.

    I would say that if German growth drops below zero, and especially if unemployment starts to rise, which hasn't happened yet, we will see Germany gradually pivot towards a more neutral stance vis a vis NATO and Russia. That could have very significant implications for both NATO and the EU.

    1. Better be careful with such near Godwin reflexes. And I'm not at all convinced a historical comparison of the current ordiliberal germany with the Germanies of 1910, 1920, 1930, or 1940 as if they were all driven by this one same single property of not spending enough makes all that much sense.

    2. Another factor that will drive Germany close to Russia is its dependence on Russian natural gas. This is in part a result of the Germany's very powerful anti-nuclear movement -- which was probably a consequence of that country's front-line position during the Cold War.

      Former German chancellor Gerhard Schröder instituted a policy of phasing out nuclear energy in Germany, and was rewarded by Gazprom to the tune of half a million euros a year once he left office. Angela Merkel realized that the anti-nuclear policy was going to make Germany ever more dependent on Russian gas and sought to reverse it, but then Fukushima happened and made it political suicide to abandon the phaseout policy.

  2. A persuasive and informative post! Thanks!

    An perceptive comment by Jon. Also thanks.

    My reaction? If Germany is resource poor with a strong need to export to sustain it's economy, aren't Japan and China in similar positions?

    It seems to me that all three countries have become very efficient producers of goods, producing far in excess of their own needs. They are competing in the international market for market share.

    Part of the international competition dynamic is the exchange rate. These rates can be manipulated to give currency areas at least a temporary price advantage.

    But, currency manipulation is a two edged within the manipulated economy. Some people will gain work from more exports but others will suffer from import price inflation, which will result in LESS consumption.

    As I write, I read that Japan has seen it's stock market average price jump by 5% due to moves by the JCB. I would expect that the retired in Japan can expect a similar DECREASE in purchasing power. And I would expect that Japan plans to gain market share worldwide at the expense of Germany and China.

    We must not forget that America imports from all these countries. The more (and cheaper) each produces, the less we need to produce in America.

    Hmmm. What is the world wide goal(s).

    1. Hi Roger,

      I don't think you can equate China with Germany or Japan like that. China is certainly not resource poor, but it is undeveloped relative to Western countries - including both Germany and Japan, of course. Its export-led growth strategy is aimed at bootstrapping its development by tapping into rich Western markets. Personally I don't think this is unreasonable.

  3. If money is principally a cooperant (like language) that allows labour and resources (including imported ones) to be put together to produce goods and services then it is important to also understand the sources for creating that cooperant so that it can be distributed over a broad base to ensure demand and supply is balanced as far as practicable. It is of little use for Neoconservatives to maintain their psychological "strict father framing" that all money isn't at root or creation "debt" or an "IOU."

  4. What effects will falling birth rates have on demand, both internally and for exports?

    1. Very good question. In the short run, not much. But as the proportion of older people in the population grows, I would expect demand to fall, partly because older people on fixed incomes don't tend to spend as much as younger people expecting future income rises, and partly because middle-aged people who are still working tend to save rather than spend. Without either a baby boom or significant immigration, German demographics contribute to its dark future.

  5. While I have read everything I come across on this subject I have never seen any convincing evidence that Germany can refloat Europe. Yes it is out performing its compatriots in the EEC but it is still small relative to the weaker economies and has fundamental structural problems of its own. Germany and indeed much of Europe is in a long term deflationary cycle driven by demographics. Do you believe that house prices, in real terms, will be higher in 2050 when 70MM Germans buy the current housing of 80MM Germans. Do you believe that Germany lacks investment when it doesn't need another school for decades and it's domestic industry is looking at 15% in overcapacity as far as the eye can see? The same can be said for Italy and the former communist Eastern Europe (the difference being that the % of overcapacity is even greater). Germany recognizes the fundamental truth that running up debt today, especially for consumption, only burdens a smaller and older population in the future. Countries such as France push Germany to forget the future and spend recklessly today. Unfortunately, even if they got their wish, the numbers just aren't big enough or sustainable enough to refloat the rest of Europe. It is a fantasy by the other countries for a salvation that enables them to avoid the reforms that are decades overdue.


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