Germany continues a policy of fiscal consolidation amidst declining business confidence, according to economic data released on Tuesday, February 23rd.
The biggest economy in the Eurozone enjoys record low unemployment (4,5%), a surging budget surplus, but decelerating growth and a declining business confidence. With negative yields for German 10-year bunds, you might have thought it is a good idea to take the money people are willing to park with the German government for a fee and invest in infrastructure.
Nope. We have a record to break.
Record government surplus
This issue at hand is ideological. The German Finance Minister, Wolfgang Schäuble, rejected a plan for a coordinated stimulus at the G20 Summit on Friday, February 26, in Shanghai. The finance minister called for structural reforms and rejected notions of coordinated spending saying “the debt finance growth model has reached its limit.” Obviously, he was referring to everyone else. Germany is not in the business of borrowing, not for some time now.
Germany released on Tuesday data indicating the biggest government surplus in absolute and relative terms since its reunification. According to its national statistical service, Germany ran up a €21 bn in 2015, or 0,6% of the GDP; this follows an €8.9bn surplus in 2014 (or 0.3% of the GDP at the time). That surplus is more impressive if one takes into account that the one-off €3,8 bn (out of €5,1 bn) is not taken into account. Most will be recorded in 2017.
However, the surplus is the result of fiscal consolidation, not merely growth. Germany has adopted a “golden rule” both at a government and state level in 2009. That rule states that the government can borrow only to invest and not to fund current spending. For years, that was only an objective; now, the golden rule it is becoming a reality.
Within 2015 Germany affected federal government spending cuts worth €10.3 bn. State governments also contributed to fiscal consolidation by €0,4 bn. That states cut deficits during boom years makes sense. But, now growth in Germany is about to step on a major break. And that is important for the Eurozone as a whole, as it is the proverbial engine of our economy.
Sliding business confidence
But, growth is now likely to step on a major break and austerity is no longer a good idea.
Over the last quarter of 2015, German GDP growth was a timid 0,3%, against a respectable annualized 1,7%. Business confidence is declining for a third consecutive month, according to the Ifo prestigious business confidence indicator released on Tuesday. The climate is especially negative in manufacturing, but also wholesale and retail. And in case you do not like the Munich based Ifo, it is worth recalling that the ZEW Indicator published last week makes the same point. Economic sentiment is at its lowest point since October 2014.
The reason is clear. Germany has an economy that is diversified, flexible, efficient, but almost 75% of its GDP looks abroad for growth. And there is no good news coming from anywhere. Chinese growth decelerates and the rest of the BRICS would be best described as “submerging economies.” The U.S, the U.K, and Japan are also seeing a major growth deceleration.
There is only one sector looking up in Germany and that is construction, boosted by new demand generated by the influx of migrants and record-low interest rates feeding mortgage-lending. Someone should inform the AfD party that enjoys double-digit appeal.
If Germany was saving for a rainy day, it is raining
Creating fiscal space in periods of growth is sound advice. A healthy surplus, reducing the debt-to-GDP ratio, creates space for times of trouble. The times of trouble are now. Tumbling energy and commodity prices are adding deflationary pressure. Demand for manufactured goods is about to slow down and competition is about to get tougher as all central banks in the developed world except the U.S – that is considering it – have moved to negative interest rates territory. Given the current levels of debt and the state of the banking system, Europe cannot afford a return to recession. So it is time to break the piggy-bank.
Germany is constitutionally allowed to borrow in order to invest. Following the Chinese example, now it would be a good time for Europe to invest in the infrastructure required for the economy of the 21st century, beginning in Germany.
Keep calm and break the rules
Germany has a short memory span. It is often forgotten that Berlin had a good decade, right after a bad one. Within the Eurozone, when Germany fails, rules change.
The EMU pact originally obliged member states to maintain budget deficits below 3% and a total sovereign debt-to-GDP ratio no more than 60%. It may be recalled that Chancellor Schröder sought French and, ironically, British support to revise these criteria as Germany had been stack into a chronic economic slump. The idea of letting Germany off the hook was then opposed by the former Prime Minister of Luxemburg Jean-Claude Juncker, on whom, Prime Minister Blair and Spanish Prime Minister José Luis Rodríguez Zapatero were exerting pressure to concede.
Later on, the loosening of that pact was reversed when Greece fell into trouble, as Spiegel reminded us in 2012.
Frankly, I don’t mind that at all. This is now less about justice and more about what works. What is the best for Germany can be good for Europe. What has been happening in Greece, Spain, Italy, and Portugal is not to the best interest of Germany. Perhaps I am completely wrong and fiscal consolidation is the way forward. We cannot all be right.
Where I am not wrong is that China is responding to Germany’s problem by going shopping and devaluing its currency. Well, we are on a weaker Euro trajectory but no one is shopping. Either Beijing is right or Berlin. If Beijing is right, what is needed is a synchronized stimulus. I think they are right. If Germany does not soon go shopping, it might soon be reduced to exporting bad news. That would be a pity, for Germany and for Europe.