Germany abhors debt. The German word for it, Schuld, also means guilt. The country’s federal and regional governments celebrate the “black zero” – zero fiscal deficits – as if it were a pagan god. The pro-business Free Democratic Party once delivered a cake in the shape of a huge black zero to the parliament of Lower Saxony, and another state government has erected a black-zero statue.
Angela Merkel promises to keep the balanced spending rule intact. But as she enters her twilight years as Chancellor, and as Germany displays fresh signs that it is plunging into recession, dragging down the rest of the euro zone with it, German governments are under pressure from much of the rest of Europe and a lot of businesses to scrap the black-zero rule. That’s because the European Central Bank is running short of ammunition to fight the next recession and reverse falling inflation rates and is pleading for governments to take up the slack.
But Germany will no doubt resist opening the spending spigot until there is another crisis, by which time it may be too late. If there is any country that can afford fiscal stimulus, it is Germany.
Germans are frugal, a country of savers who believe that spending more than you make typically ends in tears. Sometimes they are right – Greece’s crushing debt load almost ended its euro zone membership during the crisis years. To be sure, Germany ran fat budget deficits in the 1990s, when it was paying for unification with the former East Germany. As German debt rose, the government decided the tax-and-spend era had to end and, in 2009, introduced a debt “brake” that limited the federal structural deficit to 0.35 per cent of gross domestic product and prevented state governments from running deficits.
A few years later, the black-zero policy, championed by austerity-mad Finance Minister Wolfgang Schaeuble, became unwritten law. There would be no federal deficit at all, even though the debt brake allowed a small one, and surpluses would be the norm, all the better to crunch the public debt. It worked. Last year, Germany’s debt-to-GDP was just north of 60 per cent, a dream figure for much of the rest of Europe. Italy’s is more than 130 per cent; those of France and Spain are almost 100 per cent. The main reason the high-debt countries are not in trouble is because sovereign borrowing rates are close to zero, even negative in some cases.
The black zero came at a cost – even before the German economy started to weaken early this year. Infrastructure spending went lacking; Germany’s roads and bridges are nowhere near as robust as advertised. The rollout of high-speed digital networks has been slow, especially in rural areas.
But the country didn’t waver from its beloved economic model, which combined relatively low domestic investment with high exports – Volkswagens and BMWs for all – and extremely high current account surpluses. It boosted its global competitiveness by suppressing wages. The euro helped. The common currency was, and remains, cheaper than the mighty deutschmark would have been. With free-floating exchange rates, the appreciation of the deutschmark would have reined in the surpluses.
The high-performance economic model worked until Donald Trump launched his trade wars, which suddenly made Germany’s export model look vulnerable. At the same time came Brexit – Britain is one of Germany’s top export markets – and a severe downturn in the vast German auto industry, whose fortunes were reversed by the Dieselgate scandal that engulfed Volkswagen and the expense of meeting tougher emissions regulations.
Germany’s economy shrank in the second quarter and there is a good chance it will shrink in the third, putting it into technical recession, defined as two successive quarters of negative GDP growth. The downturn came as a shock to Germany, which had led the European revival after the financial crisis.
And the grim economic news has proven relentless. This week, data supplied by IHS Markit showed that German industrial output shrank at its fastest rate in a decade in September and growth in services softened. As Germany goes, so goes the euro zone, whose manufacturing sentiment index is slipping deeper into recession territory. In September, it reached an 83-month low.
Manufacturing PMI: Germany
vs. eurozone
Seasonally adjusted. Greater than 50 signals
expansion; less than 50 signals contraction.
70
Eurozone
Germany
60
50
40
30
'06
'08
'10
'12
'14
'16
'18
the globe and mail, Source: IHS Markit
Manufacturing PMI: Germany vs. eurozone
Seasonally adjusted. Greater than 50 signals expansion;
less than 50 signals contraction.
70
Eurozone
Germany
60
50
40
30
'06
'08
'10
'12
'14
'16
'18
the globe and mail, Source: IHS Markit
Manufacturing PMI: Germany vs. eurozone
Seasonally adjusted. Greater than 50 signals expansion; less than 50 signals contraction.
70
Eurozone
Germany
60
50
40
30
'06
'08
'10
'12
'14
'16
'18
the globe and mail, Source: IHS Markit
The ECB responded by cutting interest rates and relaunching the quantitative easing program. ECB president Mario Draghi, realizing that monetary policy is getting tapped out, practically begged governments to spend. “Now is the time for fiscal policy to take charge,” he said this month.
The remark was clearly aimed at Germany, which has ample fiscal room because its debt-serving costs are plummeting – to the point that they are insignificant relative to the size of the economy. German 10-year bond yields are minus 0.58 per cent, meaning investors pay the government for the privilege of owning its ultrasafe debt. The country still runs a budget surplus.
What could Germany do? It could unveil a credible climate plan – the one introduced this week was pretty lame – with a focus on engineering solutions. It could rebuild its decrepit infrastructure and boost wages to deliver a jolt to domestic demand. Its reluctance to do so is bizarre, given the negative yields on German debt. The old argument that expensive debt is enslaving future generations no longer holds true in Germany’s case. The rest of Europe is practically begging Germany to use fiscal stimulus to boost its economy. Higher domestic demand would soak up exports from France, Italy, Spain and elsewhere.
Europe is in a strange place. The countries that can afford to spend more – Germany and the Netherlands, primarily – are culturally or legally resistant to the idea. The countries that want to spend more, such as Italy, can’t because they’re financially weak. Over to Ms. Merkel. It’s time to erase the black zero and do Germany and Europe a big favour.
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Eric Reguly