The German Question

 | Jan 18, 2012 | 3:00 PM EST
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After Standard & Poor's downgraded a number of European nations and the European Financial Stability Fund, what's in store for its largest economy -- Germany?

We learned recently that its economy contracted slightly in the most recent quarter, and the current quarter might also show a slight contraction, which could mean that Germany may face a shallow, technical recession. Meanwhile, the German government cut full-year 2012 economic growth prospects to 0.7% from 1%. Both import and export growth are expected to move lower this year compared to last, with exports projected to grow by 2% (8.2% in 2011) and imports to grow by 3% (7.2% in 2011).

Domestic consumption is forecast to grow 1.1% in 2012, down from 2.2% in 2011. The government forecasts slower growth in capital expenditure by businesses, predicting growth of 2% this year after growing 8% in 2011. Despite this slower growth, the unemployment rate is projected to fall to 6.8% this year from 7.1% last year. On balance, though, while a bit on the softer side, Germany's economy is in much better shape than many other European economies, especially given Germany's export machine that extends well beyond its neighbors.

Germany is on track to meet its goal of virtually eliminating its structural budget deficit by 2016, so some pundits have called for Chancellor Angela Merkel and her government to stimulate the economy through a spending program. Some argue a spending program might help its embattled neighbors, who are currently suffering very difficult economic conditions, due largely to their own austerity. A spending package is possible based on the country's current budget condition, though spending in the past has resulted in accumulated government debt as a percentage of GDP that was 83% in 2011.

So even though its deficit is very low, its debt load relative to GDP is still in the same general league as Spain, Ireland and France, which were all downgraded. Adding to that debt won't help Germany's credit profile much, even though its budget may currently allow a bit extra deficit spending.

But what would a government spending program do, really? Germany's economy is suffering a bit because of lack of demand for its exports among its major trading partners. According to the German Federal Statistics Office, its biggest export markets include France (10.2% of total exports), U.S. (6.7%), Netherlands (6.7%), U.K. (6.6%), Italy (6.3%), Austria (6%), China (4.5%), and Switzerland (4.4%). When one considers that exports account for roughly 40% of the German economy, it's easy to see how a drop in demand from Italy or France could affect the German economy at the margins. German exports tend to be things like vehicles, machinery, chemicals and metals -- basically things that a government spending program focused on generating internal demand isn't likely to stimulate, nor likely would it replace private demand for those products with demand from the government.

And stimulating Germany's economy might not help its neighbors all that much, either. Its imports tend to be related to the things it exports -- industrial equipment and the materials that go into making things, often for resale elsewhere and not so much for domestic consumption. It doesn't import much from Greece, Portugal, Ireland or Spain. Its top import markets include Netherlands (8.5% of total imports), China (8.2%), France (8.2%), U.S. (5.9%), Italy (5.9%), U.K. (4.9%), Belgium (4.3%), Austria (4.3%), and Switzerland (4.2%). To illustrate in an example, embarking in a stimulus program where imports from Italy work out to be (doing some math here) 2.4% of Germany's GDP and 3.7% of Italy's GDP, it wouldn't move the needle all that much to Italy's benefit in a meaningful sort of way.

So, there seems to be little reason for Germany to risk the political damage from flouting its own advice to neighbors to balance their books. Why would other countries wish to practice the austerity that Germany espouses if Germany were to reverse course itself?

Of course, Germany might actually benefit if the euro weakens considerably. The goods and services sold by German companies would become cheaper in every market in which it competes with, say, American companies. I discussed this in detail in my column, "Trading One Risk for Another." Though that was written from a U.S. perspective, the converse applies to eurozone companies and economies. As such, a weaker euro could further empower Germany's export machine, though I note that the expectations right now are for just modest growth in exports, as I noted in the beginning of this column.

Still, the currency might depreciate further. I'll leave currency forecasts to currency analysts, and in that regard, Ed Ponsi lays out his view of the direction of the euro in "Projecting the Euro's Downside." In an odd sort of way, there may actually be some bright spots in euro troubles for Germany, and as such, I'm not as inclined to worry about Germany as I am other countries in Europe.

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