The German economic locomotive has hit the buffers. What can we expect to happen next?

As 2012 has moved into summer and now autumn we have been seeing increasing signs of economic weakness in the Euro area. this has placed pressure on a system that was already under pressure. One of the features of this has been that countries which were considered to be core Euro members have begun to see economic weakness too. Even the economic locomotive and central core economy that is the Federal Republic of Germany has been suffering from a slow down. Indeed even the German Bundesbank (central bank) has established that it too has some concerns in its latest monthly report.

There are increasing signs that a perceptible expansion of economic growth in the third quarter of 2012 will be followed by stagnation or even a slight decrease in gross domestic product in the final quarter of the year

Central banks  forecast economic contractions for their own economy with the enthusiasm of someone going to the dentist to have a tooth pulled.

Germany’s Purchasing Manager’s Index

This morning has seen the latest numbers released and they are the most up to date information that we receive and as you can see it is not good.

At 48.1 in October, the seasonally adjusted Markit Flash Germany Composite Output Index was down from 49.2 during September and signalled a further moderate reduction in overall private sector business activity. The index has now posted below the neutral 50.0 value for six consecutive months.

It gives some food for thought on the situation when one is considering six months of contraction in Germany and we get something of a challenge to an economic stereotype if we look for where this is most pronounced.

Manufacturers pointed to a sharp and accelerated decrease in new orders intakes during October, thereby extending the current period of decline to 16 months.

This has been driven by weaker export numbers and we get a glimpse of what is going on in the periphery of the Euro area from this.

Reports from survey respondents overwhelmingly cited weakness in export markets, especially southern Europe.

It looks as though this was particularly driven by falling car exports to southern Europe. And the effect is that the manufacturing reading for Germany is now 45.7.

So on the most up to date reading that we get it looks as though Germany’s economy is struggling.

German IFO (Information and Forschung (research)): index

The business climate data from the German IFO has backed up this situation and can be summed up by this sentence from its report.

The clouds over the German economy are darkening.

If we look beyond such dramatic prose we see that the reading for the business climate fell from 101.4 in September to 100 in October where the base of 100 is 2005’s reading. So we have six months of falls in the reading now and all of the sub-components also not only have negative readings but also have weaker readings than last month.

What does this mean for the Euro area as a whole?

We see that the effect of Germany catching an economic cold impacts all over the Euro area.

The Euro zone sank further into decline at the start of the fourth quarter, with the combined output of the manufacturing and service sectors dropping at the fastest rate since June 2009.

The reading of the overall composite indicator is 45.8 which is the third monthly fall in a row and the lowest reading for 40 months.We also find ourselves returning to a theme of this blog which is the danger of 2012 becoming a re-run of the severe contraction of 2009. If we look at Germany’s overall reading we see that there must have been more pronounced weakness elsewhere.

A worse performance was again seen outside of France and Germany, however, where output fell on average at the fastest rate since May. This extended the sequence of sharp decline that has been evident throughout the past year.

A particularly steep drop in service sector confidence was seen outside of France and Germany.

So we see that countries which were already in an economic slow down are likely to see further reverses and if the quote below is any guide then there is no end to this currently in sight.

Further declines in activity over the coming year were signalled by another deterioration in business optimism in the service sector, which also suggests that employment looks likely to be cut again. Service providers were the gloomiest about the 12-month outlook than at any time since February 2009.

If we use this information to look at the situation now in the weaker Euro area economies we see that for them the situation continues to deteriorate. It was only yesterday that the Bank of Spain estimated that the Spanish economy had shrunk by a further 0.4% in the third quarter of 2012. If that proves to be accurate then the danger is of a larger fall in the fourth quarter in my opinion as austerity and economic weakness make their by now familiar dance which increasingly resembles one of those depression era dance marathons described in the film They Shoot Horses Don’t They?

So as we look forwards we can expect this.

The Euro zone has slid further into decline at the start of the fourth quarter. The survey is running at a level which is historically consistent with the region’s economy contracting at a quarterly rate of over 0.5%. Official data have shown surprising resilience over the summer compared to the survey data, but the underlying business climate has clearly deteriorated markedly in recent months. While GDP may decline only modestly in the third quarter, a steeper fall looks to be on the cards for the fourth quarter

I agree completely with the view that official data appears to be lagging what is taking place by more than usual.

France is in trouble too

The business surveys have been picking up signs of a fair bit of economic weakness in La Republique in recent months. Whilst the overall  composite purchasing managers reading is at 44.8 in October which is better than the 43.2 of September it still represents a considerable rate of economic contraction. Much more of this and discussions of whether France is a core Euro nation or not will return with greater force and more focus will be concentrated on the prospects for her weakened banking sector.


We see today that the real economy in Europe remains troubled and in fact continues to weaken with even Germany increasingly suffering. The poses very ominous questions for the peripheral nations in my view and as we have seen above France is being sucked into that category by the economic vortex inflicting itself on Europe. However we have seen for a while a divorce between deteriorating economies and their financial markets as 2012 has developed and the European Central Bank has made grander promises. But today has seen some evidence which may be a signal that they will not be divorced for too long. From Eurostat.

At the end of the second quarter of 2012, the government debt to GDP ratio (in the Euro area) stood at 90.0%, compared with 88.2% at the end of the first quarter of 2012.

So if we take the fairly safe assumption that the ratio is now over 90% and rising I am reminded of the work of Carmen Reinhart and Kenneth Rogoff which told us this.

First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.

So we get an opportunity to see if their work turns out to be correct on the Euro area as a whole. It seems to be working right now but I am immediately reminded of the correlation does not mean causation argument. Also I wish to make it clear that 90% is in my opinion an example rather than something like the sound barrier where one enters a new world. But we find another recessionary/depressionary influence just when we least want or need it.


5 thoughts on “The German economic locomotive has hit the buffers. What can we expect to happen next?

  1. So with Germany now in trouble we can expect things to get worse elsewhere in Europe? What has happened with the rescues that so much of the media keeps telling us about?

  2. Hi Shaun,

    Another great piece of analysis on the Eurozone crisis and how the fall out is affecting many countries.

    But there is nothing to worry about with these worsening statistics as Hollende has pronounced that the Eurozone has turned the corner and the worst is now behind them. We know that when a French president speaks on Eurozone economic matters that they are always right. Just look at Sarkozy, he proclaimed when the second Greek bailout had been agreed that the Greek problem was now solved!

    Now back to reality. I see Greece has been given two more years to sort their economic disaster out, but have had to agree to just what they need, more austerity.

    After the markets giving the ECB the benefit of the doubt of the bond purchase program and a Eurozone banking union. Now the banking union can has now been kicked down the road until after the German elections in 2013 and the Bundersbank saying they will insist on tough bailout terms for Spain, I think the song from Yazz signals where Southern European bond interests rates going to go:

    “The only way is up”

    I understand that with Spain’s current bond issues they now have enough money to see them through to the end of the year. So it looks like the real fireworks will start in 2013.

    Jim O’Neill of Goldman Sachs I thought made a very interesting comment at a DT business conference last week:

    “It’s not really ‘what about the [US] fiscal cliff’, or whether Greece will survive in the eurozone or not. It’s what is going on in China, Brazil, Russia, India, and some of these other nations that are becoming so important to us as well.”

    “Last year China’s growing economy created the equivalent of a new Greece every three months, he said. Together the BRICs – Brazil, Russia India and China – created the equivalent of a new Italy, the world’s eighth biggest economy, in just 12 months.”

    Which just goes to show that the Eurozone is driving a massive economic block more and more into an economic backwater!

    It also shows how important it is for the UK and other European countries to be concentrating on increasing exports to countries where there is economic growth.

    • Hi Rods

      Thank you. What is it with French President’s and phrases which exhibit hubris and leave them hostages to fortune? I still expect Sarzoky’s blaming of the intial credit crunch problems solely on Anglo-Saxon banks to return to haunt him.

      As to putting effort towards the rest of the world I completely agree. Going forwards that is (hopefully) going to be where growth can be found. Unfortunately our political elite’s minds seem to be concentrated on jobs for them on the EU gravy train and seem unable to differentiate between good for them and good for their country.

  3. As stated car exports to southern Europe has fallen dramaticaly and France is giving aid to shoreup it’s own car industry.But with more austerity creating further unemployment this situation will not change in the foreseeable future.

    • Hi Midge

      The vehicle sector may turn out to be the equivalent of a “swing state” in the US Presidential election. It has benefitted from aid in the US and Japan for example but now that phase is over we will see if it can stand on its feet. The plant closure by Ford in Genk today may be the start of others and the downwards cycle moves on another step which will be a bit longer if the rumours about the UK Southampton plant turn out to also be true.

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