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Tuesday, December 11, 2007

ZEW Investor Confidence Index December 2007

Investor confidence in Germany dropped more than economists forecast in December, reaching the lowest level in almost 15 years, as rising credit costs dimmed the outlook for economic growth. The Mannheim-based ZEW Center for European Economic Research said its index of investor and analyst expectations fell to minus 37.2, the lowest since January 1993, from minus 32.5 last month.

InterBank Rates

The cost of borrowing euros for three months rose to the highest since December 2000 today as banks seem to be hoarding cash to cover their commitments over year-end. The euro interbank offered rate, the amount banks charge each other for such loans, rose 3 base points to 4.93 percent, the European Banking Federation said today. That's 93 basis points more than the European Central Bank's benchmark rate. If we look at the latest available data from the British Banking Association we will see that the three month euro Libor rate turned up once again in mid November, and has not stopped rising since.

It is important to realise here that this movement in the 3 month libor that we see since the start of August has taken place without any change in interest rates at the ECB. But these rates will affect all those borrowers who are on variable interest rates tied to Euribor (or Mibor) and, for example these are nearly 80% of mortgage holders in Spain, so a sharp tightening is now taking place, even as general economic conditions deteriorate.

Growth in Germany is expected by virtually everybody to slow next year, although no-one really knows by how much, and downside risks abound. A drop to 1.7 percent next year was forecast by the RWI economics group last week, but even this may be on the optimistic side.

German Exports

Meanwhile German exports unexpectedly rose in October, pushing the trade surplus to a record.

Still, the euro's 11 percent advance against the dollar this year is making German exports less competitive abroad, adding to concerns. Exports were the driving force behind last year's 2.9 percent economic expansion, which was the fastest in six years. And if we come to look at the evolution of the year on year growth rates in exports (which is the key data point I would argue), we can see that the trend is now definitely down, and indeed that the export component in this present expansion probably peaked sometime in the last quarter of last year.

So what can we expect from this. Well it may be worth reminding ourselves about what happened last time round, ie last time the acceleration in the Y-o-Y growth rates in German exports effectively stalled. That was back in early 2000, as we can see from the chart below. And what happened at that time? Well the fed was easing as the US entered recession, and the euro was to some extent rising, both of which put a strong break on German exports. So it isn't the rise in the currency alone that matters, you have to think about the whole environment which produces it. Why your currency is rising, while someone else's is falling. And of course, in German export terms, after the rise comes the fall. This is the cost of not being able to depend on your own internal demand, you have to depend on someone else's demand.

As we can see once the rate of increase in annual exports entered real decline, GDP was not far behind, and off Germany went into recession. So this time round the same thing may well happen, and domestic demand may well not offset any fall-off in foreign sales as oil-driven inflation and rising borrowing costs steadily sap German consumer and corporate spending power. Last month, consumer prices rose 3.3 percent from a year ago, the most since records began in 1996. The price of oil has gained 44 percent this year. At the same time German wages, as is well known have had only very weak increases in recent years.


Following some discussion in the comments section, I am adding the following charts to try and clarify what I am saying about internal consumption and construction. The first chart shows clearly how the construction and housing sectors are in long term decline in terms of their importance in the German economy. If we leave of the very exception Q4 2006 and Q1 2007, housing simply hasn't turned back up since the end of the boom in 1995. As I keep saying I think the strongest explanation for this is the demographic one, and it is this element that those who keep hoping against hope to get a turnround simply are not seeing.

If we look at the most recent data, it is clear that there is an annual cycle, but otherwise there is very little movement, except for the uptick at the end of 2006, begining of 2007.

If we now look at the co-movement of a number of different components - exports, GDP and housing - we can see that every time the rate of increase in exports slows (the green line), GDP (the red one) follows it down. And at the moment, of course, the rate of export increase is slowing. If we then add to this what is happening in housing and construction, where we have a very rapid decline from the VAT rise provoked boom (houses also went up 3% on 1 January 2007), and the deteriorating external environment, it isn't at all clear to me at this point that we won't see a German recession in 2008, in fact I would put the odds on a German recession slighly higher than the 40% probability most people are attaching to a recession in the US (let's say 50-50).

Finally, as I keep indicating, the backdrop to the whole situation is the vulnerability of domestic consumption, and quite how fragile all this is has been brought home by the boom-bust type dynamic produced by the VAT hike, which can be seen at the end of 2006.

Of course, it is not only Germany's median age which is rising, the population structure is in continuous change, and in particular the proportion of the population in the key 25-49 age group is now falling. Let's look at the chart:

As can be seen from the chart this crucial age group touched its highpoint in 1997/98, precisely around the time that the mid 1990s boom in construction came to an end.This could be imagined as the moment of maximum capacity for the German economy as a whole. In closing I would wish to point out that I am not trying to draw all this to your attention in order to criticise, or in some way have a go at Germany. Au contraire. It is because I am concerned that I am going to all this trouble. The first step to getting to grips with and fixing a problem has to be recognising that it exists. That drop in fertility that happened deep in the past, may now seem like a long forgotten event, but its presence is forever with us. Something obviously needs to be done, and better late than never. Putting all your eggs in one basket is never the best of ideas.


Anonymous said...

Well, in 2000 the German construction sector was only half way through its 10 year slump. This was a serious drag at that time. It is hard to imagine that the same will happen again.

Edward Hugh said...


"It is hard to imagine that the same will happen again."

Are you sure? The core of the argument that Claus and I are advancing is that this is a more or less permanent shift, away from construction as a driver of growth that is. This is why the German economy has become export dependent. Try the charts in this post here.

Our argument is that as median ages steadily rise construction plays a less and less important role. This is logical when you think about it, since there are proportionately less and less young people borrowing money for new homes (this is the difference between what Wolfgang Munchau calls the "English speaking" societies who borrow money (Spain and Greece are not English speakers, although Ireland of course is). It is the comparatively younger median ages that seem to matter, not the language or local culture (they don't speak German in Japan, and they are remarkably similar structurally).

Initially the problem is masked to some extent, since govt funded civil engineering projects take over some of the weight, and up goes the national debt. This then - as we are seeing in Germany, Italy and Japan - hits a ceiling that people are prepared to tolerate (which varies according to the local culture it seems) and the these works steadily dry up as governments focus on getting the public debt sustainable to face the looming rise in elderly dependents. So again here, median age modulates the situation somewhat.

In 2006 a lot of external money went into both Tokyo and Berlin, due to the "win-win" decoupling story that these two economies were finally recovering their autonomous local demand as a driver, this, as we are seeing, has not been the case, and this is why these two countries are suffering particularly on the backs of the US sub prime sparked global credit squeeze. So my guess is that if anything the downswing in Germany will be worse this time round, and thr trigger is a slowdown in the US, not for its export market effect, but due to the way this changes the interest rate cycle. The ECB only starts to lower rates when it is clear that German exports have cracked, unlike the US Fed which takes a risk and tries to get ahead of the curve. Its a pity really, since I say this as a European. Oh, and don't forget, the big difference this time round will be the drag which Spain represents for eurozone domestic demand growth during the downturn. The Spanish construction sector has just entered its ten year slump :).

Anonymous said...

My point was, that with the construction sector now down to a sustainable level it won't be the drag this time around. In fact, the lingering effects of the cuts in construction subsidies will fade, so construction should be stable.

Additionally, Germany has improved its competitivenes. While this is not a shield against everything, it should keep Germany closer to the European average.

As to your praise for the Fed: the same policies that created the current mess are supposed to be the cure? No, thanks. Europe might pay with slower growth, but at least it will not live on wealth borrowed from the future.

Edward Hugh said...

"My point was, that with the construction sector now down to a sustainable level it won't be the drag this time around."

Sorry, my mistake. I thought you were talking about after 1995, not in 2000. Then my original point stands, I think (the one in the post): Germany is now export dependent, competitive or otherwise, and her performance will depend on the performance of her customers, just as it did in 2000, or possibly, even more so, since the population is now older.

The construction share now is more or less where it was in 2000. The only blip was the surge in 2006, which got everyone so excited. Now we are back to normal, with some downside to subtract after the excesses of 2006.

"As to your praise for the Fed: the same policies that created the current mess are supposed to be the cure?"

Look. I think you are looking at this politically, and I think that is a mistake. You know, the old EU-US football match. What I am asking is why the ECB is always behind the curve. It was behind in 2000/2001, and it is again in 2007/2008. The ECB will lower rates, but it will take its time and then they will be down lower and down for longer, depending on how deep the recession is in Germany, Italy and Spain.

"Europe might pay with slower growth, but at least it will not live on wealth borrowed from the future."

The element you don't seem to be taking into account is the ageing one. The issue in many European societies now isn't borrowing from the future, but paying back to the past, to the people who paid their contributions to the health and pensions systems, and who are now waiting to receive. To be able to honour these commitments we need to be able to grow, otherwise our states (with Germany in the forefront) just won't have the resources to cope with the scale of the problem. Take the Italian case. If the Italian state isn't going to be forced to declare itself bankrupt, then the Italian economy needs to be able to grow at over 2% a year, something which it hasn't achieved in more than a decade now.

The thing is this whole debate needs to stop being politicised, and to come out of denial and the "armario". We need an honest and open debate about the real problems we are facing, and how we can realistically confront them, not the sort of "goldilocks recovery" pipedreams we have been living on.

I may be right, or I may be wrong on the details, but I am, I think, in the right ballpark.

Anonymous said...


First of all I apologize for my English, my mother tongue is Spanish. My name is Paula Villa, I am in last year's Civil Industrial Engineering at the University of Chile. I am currently investigating how to create an index of investor confidence for investment in Chile, you have already created a methodology and have experience in this. I would like to know as they have to be able to adapt their methodology and implement something similar here.

I hope can help me and guide me in this challenge,

Thanks in advance,
Paula Villa