Germany could talk tough when it was Europe's economic superstar, but as its industrial growth slows to a crawl, the country's fierce loyalty to a hair-shirt version of macroeconomics needs rethinking.
The latest serving of economic data demonstrates the extent of Germany's doldrums. On Tuesday, the government cut its growth outlook to a mere 1.2 per cent this year (down from 1.8 per cent in April) and slashed its forecast for next year to 1.3 per cent (down from 2 per cent).
The yields on 10-year German government bonds plunged to record lows of 0.84 per cent as investors scrambled for safety. As economists at the Bank of Nova Scotia noted, the ground-scraping yields mean that once you deduct the impact of expected inflation, the yield curve "is pricing in no growth in the German economy for the next decade."
Germans themselves are growing convinced that the stein is half empty. The latest poll by Zew, a German think tank, shows that analysts and investors' assessment of current conditions slid to a reading of 3.2 in October, down from 44.3 in August. Forward-looking sentiment dipped below zero, the 10th straight month it has declined.
But Germany's power brokers seem oddly unperturbed by signs of distress. In an interview with news magazine Der Spiegel in late September, Jens Weidmann, the head of Germany's central bank, stressed again that he was against any move to stimulate the continental economy with more government spending.
"Solid budgets … are a precondition for, not a contradiction to, sustainable economic growth," he said. He emphasized the need to build confidence by cutting down on deficit spending and by reforming the "administrative structures" in crisis-hit countries. "Growth and jobs are ultimately produced by private companies … To promote that, the public sphere must create the necessary framework."
The Germans have a word for this belief. It's called ordoliberalism and is a uniquely German variant of standard economic thought developed in the middle part of the last century.
At its core is the belief that government has an important role to play in constructing the conditions that will let the market function as it would in a perfectly competitive world. For instance, government should step in and control cartels and potential monopolies, according to Germany's ordoliberal thinkers.
However, that's where government's role stops. Unlike many Keynesian economists, ordoliberals don't believe in using expansionary fiscal policy to counteract a recession. In keeping with that conviction, the government of German Chancellor Angela Merkel rejected calls on Tuesday for increased public spending and reiterated its commitment to achieving a balanced federal budget – die schwarze Null, or the Black Zero, as the German press calls it.
"Mainstream German opinion believes that harsh austerity measures are the key to breaking the cycle of debt and the threat of insolvency, reassuring the private sector and thus triggering natural and sustainable growth. Arguing about this will not change their mind," wrote Sebastian Dullien, a senior policy fellow at the European Council on Foreign Relations and co-author of a 2012 paper on The Long Shadow of Ordoliberalism.
If arguments won't change German minds, a slowing global outlook might. Germany's economy has owed its relative prosperity to a huge current account surplus that has, until recently, amounted to more than 7 per cent of its GDP. But that surplus hinges on other countries' willingness to buy German exports of goods and services. As China slows, and as Russia's incursions in Ukraine cast a chill on Western Europe, German exporters are likely to find lower demand for their products.
Meanwhile, the country's ordoliberal distaste for deficit spending prevents any fiscal stimulus that would encourage demand within Germany. Without strong German demand, the hardest hit countries of the euro zone will find it difficult to run their own trade surpluses, a necessary prerequisite for paying back their debts to Germany and other foreigners.
As economist Paul Krugman and others have noted, Germany's stance is effectively a demand that every country start running its own current account surplus – a logical impossibility since every current account surplus in one country must be matched by a current account deficit in another. For ordoliberals that may not seem like a contradiction, but for other Europeans, and for global investors, the math simply doesn't add up.
Ian McGugan