Germany officially leaves the growth track… More chances for Asia?

On October 14, the last growth engine in the eurozone officially backed out. Germany’s economics minister, Sigmar Gabriel, announced that the country’s GDP growth this year will be 1.2 percent instead of the expected 1.8 percent – if one trusts even this new forecast.

Because Europeans have long forgotten what real economic growth looks like, a GDP rate of 1.2 percent sounds very seductive. In my opinion, the truth is somewhat more modest, with an even lower rate of expansion the likely result. Germany has in fact had very low economic growth for a long period. In 2012, GDP growth was 0.7 percent and last year it was 0.4 percent. The start of 2014 had a good dose of optimism based on what looked like an economic tailwind. The labor market in Germany was quite robust, which is what Gabriel still refers to. But otherwise the German government, like all other European governments, based its optimism on external factors. Put another way, the hope was that the growth in the rest of the world would increase European exports.

The last hope I have never seen as realistic because global growth is under pressure. Expansion in the United States is largely domestically oriented, originating in the construction sector. In China, it is difficult for Western companies to participate in the growth because the market is complicated. Therefore, I have so far not joined the hope about higher growth in Europe because there obviously is no own internal power to generate expansion – on the contrary. For the same reason, my most likely scenario throughout 2014 has been that the eurozone falls back into recession next year. In this assessment, the German economy obviously plays an important role. After the official announcement on the October 14, I have raised my expectation about a recession in the eurozone in 2015 from being “very likely” to “most likely.” A reinforcing reason is that I doubt the new lower growth estimates from the German government. Just to meet the new lower expectations requires that economic growth in Germany will increase from the current level, which is extremely doubtful. GDP growth for the first half of this year was at a dull level, around 0.35 percent, and is thus unchanged from last year.

During the first quarter, German consumers were quite optimistic and spent more money. Since then, the money has remained in pockets, and as soon as German consumers feel a touch of crisis they stop spending. Therefore, I expect that they will stay very quiet for some time apart from the traditional Christmas shopping, which I hope will be satisfactory. But the reluctance of German consumers is, to the surprise of many, also related to the labor market. The seasonally adjusted unemployment figures are actually beginning to be soft, though Germany is also affected by the same problem as many other countries. Too many of the newly created jobs are in sectors with generally low wages. Even in Germany this means that an increasing number of people must have an extra job to cover the cost of living. A natural consequence is that the disposable income for consumption of goods is limited, surely below the expected purchasing power compared to what the positive labor market otherwise would indicate.

At his press conference, Gabriel featured turmoil in Ukraine and the Middle East as an explanation for the unforeseen economic headwinds in Germany. I totally disagree, despite the fact that some sectors of the economy are partially affected by the unrest and trade sanctions. But if Europe and the global economy were doing well, then the turmoil would have no significant impact. Furthermore, one should take into account that Germany enjoys an extraordinary economic impulse from the construction sector. The extremely low interest rates in Europe lead German investors to invest in the property market and therefore the construction sector is booming. One can argue that the cure of the extremely low interest rates works in this case, which is a fully legitimate argument in my opinion. It just has the consequence that the German property market is heading toward a bubble. However, there are no strong signals that it is about to burst. In the overall assessment of the German economy, one should include that of the sectors contributing positively to growth, it is strongly supported by an artificially created bubble.

As a higher GDP growth in Germany next year should have helped to keep the eurozone growth above water, it is natural for me to argue that growth in the zone will suffer in 2015. I am not alone in my pessimistic view, but I still belong to a minority. In a few months’ time, I expect however, that the development will contribute to renewed negative headlines and deeper concerns about the outlook for Europe in 2015. This is of course a serious issue for Chinese exporters, though it is not the only concern. I continue to have the expectation of a dropping euro exchange rate due to the sluggish economic news. Seen from a Chinese perspective, it means that the Chinese goods will become more expensive on the European market. The challenging outlook is becoming apparent for European politicians as well. Therefore countries like France and Italy will soon argue for increased public investments and debt. What companies and investors really should worry about is the fact that the intervention from the governments basically helps maintain the status quo. To generate attractive and healthy investment opportunities reforms are required rather than the status quo. Because this will not happen in Europe in the foreseeable future, I maintain my view that investors back out from the eurozone and go elsewhere – most likely searching for opportunities in Asia.

 

*Disclosure: Peter Lundgreen is the CEO and founder of Lundgreen’s Capital, an investment consulting and advisory company. The views expressed in this article are not necessarily The Corner’s.