If China’s economy crashes, it will devastate the eurozone – and the UK

A Chinese economy in the doldrums will leave Germany painfully exposed, says Matthew Lynn. That's bad news for Britain and Europe.


Germany's economy will be left exposed by a depressed China

The strong man of Europe. The only remaining locomotive of the European economy. The one country with the discipline and financial strength to keep the single currency together, and to pay for the bailouts of its weaker members. Most people assume that the German economy is rock solid, one of the few anchors of stability in a generally weak global economy. That may turn out to be completely wrong.

Germany's economic engine has been driven to a great extent by a boom in exports to a fast-growing China. With China slowing even crashing it is hard to see what will replace it. The underlying decline in German competitiveness will be painfully exposed. And that will pose a danger to the rest of the continent.

Wobble or crash?

Whether China is going through the kind of stockmarket wobble you'd expect of an emerging market, or is staggering towards a full-blown economic crash, is too early to say. Stocks surged earlier this year, and have now come spectacularly back down to earth. What does seem clear is that Chinese growth of 10%-plus per year can't be sustained, and the country is likely to grow by around 5% or so annually in the decade ahead. Most countries would be pretty pleased with that. But when an economy slows, all kinds of problems come to light and a collapse can't be ruled out.

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When the Shanghai market fell by 8.5% on Monday, the ripples spread across the globe. Stocks were hammered everywhere. But Germany's benchmark Dax index was among the hardest hit. Why? Because Germany is the country that has benefited the most from China's industrial revolution. The German success story of the past decade low unemployment, robust growth and relatively low debt has made it the strong man of the eurozone. Most people put that down to reforms that made its labour market more competitive; the strength of its medium-sized manufacturers; and, well, the Germans being German, and so incredibly efficient.

There was some truth in all of that. But the reforms were in fact fairly modest (Germany still has some of the highest social spending in the world). And manufacturing has not been much of a help to other developed countries. Just as important were an undervalued currency, and the creation of a vast new market.

The truth about the German boom

As China emerged from communism, and started growing at 10% a year or more, it was the perfect market for Germany. It sold China the machine tools that are vital for a country which is building new factories by the hundreds of thousands every year. And it makes the kind of luxury goods that newly rich entrepreneurs want most of all such as shiny new BMWs. Total German exports to China now amount to £100bn, or 6.6% of everything the nation sells abroad.

That is led by cars the Chinese import almost as many German vehicles as the far richer Americans and machine tools. Meanwhile, German exports amount to $1.5trn a year, and have grown by almost 20% since 2010, despite a generally stagnant global economy. That has resulted in a trade surplus that comes to a massive 8.1% of GDP, one of the biggest in the world. Most of that growth has come from China. Without that boost, its economy would not be in nearly such good shape.

Not as efficient as you think

Unfortunately, China's boom has masked the fact that the underlying German economy is not in great shape. Retail sales have been largely flat for a decade, mainly because real (after-inflation) wages have barely risen. The country's infrastructure, while impressive, is not being renewed. If you think we are bad at big building projects, look up the ongoing fiasco that is Berlin's new Berlin-Brandenburg airport ("the building site of horrors" as the German press has called it).

Germany's energy costs are now 30% above the European Union average, which are themselves far higher than most of the rest of the world. Why? Because it closed its nuclear plants, and adopted expensive green policies. Germany has plenty of shale gas but zero chance of exploiting it the Germans don't like fracking. For a country that exports manufactured goods, expensive power is crippling.

Meanwhile, Chancellor Angela Merkel's coalition government has been ramping up costs for industry. It has introduced a minimum wage, made concessions to the still-powerful trade unions, and is likely to place restrictions on temporary employment. Economists despair of Merkel's lack of interest in the economy's competitiveness. Meanwhile, Germany's demographics are about to fall off a cliff, with a steeply falling population. If you want to know how that impacts on growth, just ask the Japanese.

Those weaknesses have been masked by the China boom. If China slumps, the biggest casualty might well be Germany. That will be bad news for us Germany is one of our largest export markets. But it is even worse for the rest of the eurozone. If Germany can't rescue the single currency area, nor can France or Spain, and certainly not Italy. With Germany in decline, the eurozone will be in worse shape than ever.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.