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Germany is quite possibly in recession.
The eurozone’s biggest economy is running aground, just as the world is starting to panic about what negative interest rates are doing to the eurozone’s vulnerable banking system.
So why did markets bounce yesterday?
Because maybe – just maybe – this is what it takes to convince Germany to loosen the purse strings…
Never mind central banks, markets are now looking to governments
Central banks have been the main game in markets for a long time. And their time may not be over yet.
But investors are starting to worry. They’re not convinced that Jerome Powell at the Federal Reserve really knows what he’s doing. There’s a fair bit of dissent in the ranks over there and Powell is nowhere near dovish enough for investors’ liking.
Meanwhile, the European Central Bank (ECB) and the Bank of Japan have already turned interest rates negative. The jury is very much out on whether that’s a good idea or not. If negative interest rates are crippling the banks, and banks are the ones who do the most lending to business (which is certainly the case in Europe), then aren’t negative rates – well – counterproductive?
In short, central banks might not be out of ammo (there’s always something else they can buy, after all). But investors are wondering if this is a problem that perhaps central banks are not best placed to fix.
Instead, if central banks have lost the power to “stimulate” easily, then it’s time for governments to step in and do the job. The hope is that government spending might avert any pending recession. The idea that markets go down as well as up, and that economies sometimes do too, is apparently not viewed as a fact of life anymore.
(This idea about recessions being bad things that can or should always be put off probably bears more discussion in the future, but let’s park it for now.)
The clearest and most present danger is in the eurozone. To sum it up, the big risk – which for all his best efforts, ECB boss Mario Draghi has not entirely defused – is that the banking system collapses and the currency follows. That’s about the only thing that I can imagine unleashing 2008-style havoc on the world all over again.
The main reason that this is still a risk is that the eurozone project is not complete. You’ll no doubt have heard all this before, but in the eurozone, there is monetary union but not fiscal union. If you want a geographic region to share the same currency and interest rates, it also needs a common budget.
So when Greece hits a sticky patch, creditors of Greece need to know that Germany is good for the bill. Otherwise a Greek euro isn’t the same as a German euro, which means you don’t actually have a common currency.
Fiscal conservatives are going the way of the dinosaur
Now that’s not going to happen any time soon. But another complaint about Germany is that it doesn’t spend very much. Instead it takes advantage of having a weak currency (the euro is arguably weaker than the Deutsche mark would be), to build up its dominance in manufacturing. In effect, it’s a mercantilist economy.
So there’s always pressure on Germany to do more public spending. If the eurozone’s biggest economy was spending more money, then that would stimulate not only Germany but also the rest of the eurozone, as German consumers bought more goods, went on holiday, and everything else.
As a result, when German finance minister Olaf Scholz told markets yesterday that the country has about €55bn that it could spend on boosting growth if the Germany economy does end up in recession, that was enough to give markets a lift.
It might not happen right away, of course. Germany is not a fan of fiscal profligacy. But the mood in general has clearly shifted very much in favour of more public spending. The US has been a big spender for a very long time, but there used to be a significant contingent of Republicans who complained about it. Now those voices are pretty much silent.
(It’s ironic and yet weirdly predictable that the Tea Party movement – which started out as fiscal conservatives – paved the way for one of the least fiscally conservative human beings on the planet to become president of the US.)
In the UK, it seems likely that a Brexit on 31 October, that doesn’t involve an immediate deal, will result in a big government spending push. And even if there is a deal, Boris Johnson doesn’t strike me as a hair-shirt-and-austerity kind of prime minister.
And at the end of the day, if the European Union wants to preserve the euro and keep le grand projet alive, then convincing Germany to spend more money is the way forward. If Germans can learn to loosen the purse strings in the name of the greater good, then maybe Germans can also learn to share their country’s credit rating with the less reliable users of the single currency.
(This does seem a stretch to me, but I’ve also realised that it’s very easy for a British observer to make the mistake of underestimating continental support for the eurozone when push comes to shove.)
In the longer run, this is why I’d expect an inflationary endgame to all of this. Of course, there’s no guarantee that we won’t get a deflationary scare ahead of that. Which is why we all have diversified portfolios, right?
And if you want to hear me talking to Merryn and her guests about all this in more detail, then come to Adam Smith’s old house in Edinburgh on Friday at 2pm. The run is almost sold out though (only tickets for Friday and Sunday left), so get your skates on! You can get hold of them here.