July 24, 2012

Is Euro Crisis Spreading to Germany?

By Mindful Money via QFinance
Because of the nature of the situation in the Euro area the situation in the periphery is often up for analysis. For example I looked at Spain’s current problems only yesterday. However if you have a periphery you also have to have a core and today I wish to look at the core nation the Federal Republic of Germany. She wears various coats for example she is the potential saviour of the Euro but often also metamorphoses into the supposed villain of the piece.
The German economic locomotive
This part of the story is something of a stereo type which I have hinted at in the use of locomotive. However if we look at the numbers from the Federal Statistics Office we see that she has lived up to such a description,up to now anyway. For example economic growth was 3% in 2011 and real earnings actually had positive growth over the year of 1.1%. Employment has continued to rise for example in May it was 41.497 million as opposed to 40.945 million a year earlier and 40.419 million in May 2010. Rising employment has meant that unemployment has fallen over the past 2 years as well giving an unemployment rate of 5.5%. And of course we have her export and trade performance.
In 2011 Germany exported goods worth 1 060.0 billion euro and imported goods worth 902.0 billion euro. In 2011, the value of German exports for the first time exceeded a trillion Euros.
This is reinforced by the fact that Germany has had a trade surplus every year since 1951,although of course back then we are only looking at West Germany. I think we can call that a trend!
So far so good,although such a good performance may already have any Undertones fans in the Euro periphery singing this song.
Oh my perfect cousin
What I like to do he doesn’t
He’s his family’s pride and joy
His mothers little golden boy
However there are problems
I have discussed before the problems with the Euro area bailout vehicles (the European Financial Stability Facility and European Stability Mechanism). For a start the EFSF has led to anything but stability. However for this purpose let us consider Germany’s share of such operations which is 29.07% right now up from 27.06% when the EFSF was conceived. The reason for the difference is that Portugal,Ireland and Greece have “stepped out” as being recipients of loans they can hardly be considered to be capital backers.
So we have issue number one which is Germany’s rising burden. And if we see Spain joining the bailout recipient list this game takes a notch higher as she alone is a larger contributor to the EFSF (12.75%) than Greece,Ireland and Portugal put together (6.9%). By default Euro officials have confessed to this issue as they are currently claiming that Spain can be both a borrower and a capital contributor because the funds about to be lent to her are for her banks. This of course smacks much more of desperation than logic,after all Ireland’s funds can be considered to be for her banks too.
Moody’s catches onto this issue
Moody’s Investors Service has today revised to negative from stable the outlooks on the Aaa sovereign ratings of Germany, the Netherlands and Luxembourg
Okay so why?
Even if such an event is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required. Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form.
As ever we see a ratings agency coming late to the party-sometimes they are so late everyone has gone home- however as discussed above there is a genuine issue here. Adding either or even worse both of Spain and Italy to the “stepped out” list would put a considerable burden on Germany’s shoulders.
There has been a market impact from this as German bond prices have fallen this morning. However care is needed as the 6 month and 2 year yields remain negative and the ten-year has only risen to 1.26%. On that subject,my chartist friend considers German bonds could be putting a price top in here anyway….
Is the locomotive running out of steam?
If we look into the heart of the locomotive we see that not everything is now going to plan.
Flash Germany Manufacturing PMI at 43.3 (45.0 in June), 37-month low.
Flash Germany Manufacturing Output Index at 42.8 (44.8 in June), 37-month low.
These are the sort of figures we have become used to seeing in Greece and more recently in Spain and Italy but not Germany. And if we look at the “37 month low” part then Prince or whatever he calls himself these days might have sung that it is “just like 2009″. Furthermore this is not just one isolated number as Germany’s performance has been falling further below the benchmark of 50 as 2012 has progressed.
If we try to peer into the future we see this.
new export orders declined at the steepest rate since May 2009
So it would appear that we are in for a period of more of the same.
The picture for the overall German economy is not as grim as for her manufacturing sector as shown below.
Flash Germany Composite Output Index at 47.3 (48.1 in June), 37-month low.
But overall output is shrinking and at a faster rate than before, and one might expect the lower manufacturing figures to feed into services as we move into autumn. Indeed below is a phrase not often used with respect to Germany.
a steeper drop in GDP (Gross Domestic Product)
Germany’s banking sector weakness
This is a subject not often discussed but Moody’s did shine a light onto a corner of the room when it reported this in last night’s statement.
The vulnerability of the German banking system to the risk of a worsening of the euro area debt crisis
This is true but there was something just as significant tucked away in this organisation also being moved onto negative watch.
FMS Wertmanagement
You see Germany has a “bad bank” for the, ahem, assets of Hypo Real Estate which would have collapsed otherwise. And it was far from alone amongst German banks in expanding into the sub-prime crisis. If we look at how things are going we see some familiar themes if we peer into an analysis of this company and unravel some of the PR spin.
Some of the structured credit risks in the FMS-WM portfolio are highly complex
If we use my financial lexicon we see that this means that they are struggling to understand them and accordingly chances of a realistic valuation are slim to none. Oh and Slim’s out of town.
Various positions are highly illiquid, for instance, in the infrastructure finance area
Not only can’t they understand or value some of these assets they can’t sell them either!
And as a final point some may be thinking that it may be somewhat naive to consider that they may even want to sell or value them….
So there are plenty of issues in the German banking sector and any economic weakness may bring a few of them to the surface.
Comment
So we find that the “my perfect cousin” version of the German economy may be disappearing in front of our eyes as summer turns to autumn. German economic weakness was certainly not in the script and should it persist it poses two questions. The most commonly asked will be external relating to her relationship with her Euro area partners and her ability to support an increasing number of bailouts. Less often asked but just as important is the domestic issue of the state of the balance sheet of Germany’s banks as any funds that have to be diverted here will be unavailable elsewhere.
And those who have sniped at the German economy when it has been strong will find that they like a weak Germany even less. Personally I wonder if we look a far way into the future we may facing a situation where no-one is a core Euro nation. If physics is any guide that means it will fly apart possibly quite destructively.

Courtesy Mindful Money via QFINANCE (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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