I have known Bob Barbera since his days as one of the best Wall Street economists, particularly during his time at Lehman in the late “80’s/early 90’s. He continues to share his knowledge with the faculty and students at Johns Hopkins (and a limited number of clients and friends). I asked Bob for his thoughts on the world, particularly as it relates to the most recent expansion (a mild term) of QE in Japan. His thoughts focus on the broader impact on Europe–specifically Germany—, but also, the rest of the world. Dr. Barbera makes some interesting points about China and growth rates. This bears watching. China’s electricity usage—an interesting measure of economic activity– 2014 YTD is a meager +2.7%. That’s not all from conservation or weather. It does likely make for China’s desire to be more forthcoming on trade negotiations and other interactions with the rest of the world as the country struggles with the transition from exports to internal consumption. As Barbera puts it, China’s bridge-building to an internally-driven economy may turn out to be a pier. Significantly, though, he points out the impact of the Yen on German competitiveness. At 80 Germany was fine. It could hide behind an undervalued Euro (relative to what the DMark would have been) and continue to export against its most direct competitor (Japan) while holding down wages. In my view, Germany has been as big, if not a bigger currency manipulator, as China all these years. Germany may have to respond a bit more to Draghi’s exhortations. See “Past Performance” for more on this, but in the meantime please Pay Attention to Dr. Barbera’s succinct and direct analysis of the various crossroads coming from the geo-economic linkages that exist today. – Jack Rivkin
German Exceptionalism? An Illusion About to be Laid Bare – by Bob Barbera
The German economy, in stark contrast to most of the rest of Europe thrived, 2010-2012. German successes emboldened their policymakers. Merkel, her finance minister and a succession of Bundesbank members all sternly lectured their European partners. Embrace Germany’s magical approach, or continue to suffer, has been the message. The good news for the rest-of-Europe is that Germany’s mansion on the hill has always been a sand castle. Two tsunami waves are about to hit. And Germany’s economic exceptionalism will be swept away in 2015.
Everyone agrees that Germany’s strength is tied to its export machine. To understand how Germany did so well 2010-2012 one needs to appreciate that two powerful developments in Asia gave Germany a giant gift over the years immediately after the Great Recession—and that gift is now being taken back. The first and most obvious? China embarked on a frenzied infrastructure and real estate build out, in an effort to insulate itself from the contractionary forces that the Great Recession foist upon the world. This created a booming market for German capital goods exports. The second, and often overlooked, is the insane appreciation of the Japanese yen. The global financial market collapse engendered a powerful unwind of the so-called carry trade. As yen denominated debts were paid off the yen rose by an astounding 35% versus the U.S. dollar and the euro!
In combination these two developments created a bonanza for German exporters. A market for their capital goods was booming. And their biggest competitor in that market, Japan, was suffering from a near 35% loss of competitiveness, due exclusively to the swing in their bilateral exchange rate. And as a bonus? Germany’s motor vehicle exports to the U.S. compete mightily with Japan’s car offerings. In the U.S. as well, Germany saw their competitive position leap, as the yen soared versus the euro. In combination, these developments allowed for a storyline of wunderkind German exporting companies, thriving due to home grown virtues.
But the world has radically changed over the past year. More to the point, both of the powerful currents supporting German growth have changed direction and the Tsunami is about to hit. How so? China’s construction boom was meant to be a bridge. A three year commitment, to allow healthy developed world growth to resume, and thereby engender a resumption of growth for China’s export machine. China thought they were building a bridge. As it turns out, they have been building a pier. Investment excesses in China now require a sharp curtailment of growth. German exports to China are bound to fall. In addition, Japan, after suffering brutal economic performance at the hands of a soaring yen, is on a mission to sharply devalue its currency. The yen/euro cross peaked at 1.05, in late 2012. At that level the yen had appreciated by 35% versus the euro. Late 2012 through mid-2013 the yen plunged amid the first round of aggressive bank of Japan QE, erasing the lion’s share of the climb. And over the past few weeks, with the BOJ surprise announcement of a second larger commitment to QE, the yen has resumed its swoon versus the U.S. dollar. And it is threatening to move lower still versus the euro.
Thus Germany now faces a world in which its locomotive, China boom, has been derailed. And its competitive edge has been blunted by a plunge for the yen. It could well be that Germany, in the quarters immediately ahead, will underperform the rest-of-Europe. Spanish and Italian exports to China are quite small. And Italy and Spain do not see Japan as a major competitor for markets.
The End of German Sanctimony?
What might this portend for European policy? Angela Merkel has stood her ground on the value of fiscal austerity. Bundesbank and finance minister proclamations call into the question the legality of a more substantial version of European QE. Belt tightening exhortations warmed the heart of folks in the hinterland—amid good German growth and with the jobless rate at an astoundingly low 5%. How firm will German officialdom sound, if German economic circumstances go south? Perhaps Germany will finally sound more like its southern neighbors, when its economy begins to look similarly distressed.