Shadow On The Wall

The June PMIs capped the best quarter for over six years in the Eurozone, fully consistent with the notion of a regain in economic momentum. The trends in Germany remain solid. Our economists have actually just increased their GDP growth expectations for this country to 1.7% (from 1.5% previously). This revision was driven by three interrelated factors: consumer spending at its highest level in fifteen years, rising housing prices after three decades of structural decline and increasing wages as unemployment stands at a record low of 4%.


The prevailing view is that Germany has been increasing its reliance on domestic macro drivers which is naturally reducing its exposure to external shocks. This is rather timely since the country risks losing some of its exports to the UK, one of its largest trading partners (larger than China). As a result, Germans feel good about their economic situation. The latest Pew survey indicates that they are amongst the most confident in the world when it comes to their economy. 86% of respondents deem it to be in good shape vs. 58% for the US and 21% for France, one of the most dissatisfied nations in that respect – which is roughly where Germany was in 2002 (27%) when its unemployment rate was above 13%.


Germany’s ordoliberalism – the emphasis on competition, price stability, fiscal restraint and the importance of rules over discretion – associated with deep structural reforms since the turn of the millennium have contributed to a favorable economic and political environment. It is boosting Germany’s confidence at a time when the US, the UK and Europe are going through an identity crisis. In fact, another Pew survey shows Angela Merkel enjoying by far the most positive political status globally, ahead of her China and Russia counterparts, with Mr. Trump trailing. This may at least partially explain why the September 24 elections are seeing her ahead. In any event, most consider the polls as a non-event from an economic perspective since no material changes to fiscal policy is expected under any probable scenario.


All is not perfect, though. As established previously, Germany’s population growth is shrinking (whilst that of France is growing – see ‘Love economics’ in April), which has a material impact on its future earnings power. Furthermore, the ginormous current account surplus – often seen as a success with exports equivalent to that of the US in dollars terms(1) – conceals excess savings due to under-investments in infrastructure by the government and in domestic capex by corporates, relative to other Western countries (check this week’s IMF report on Germany). Here lies a paradox, it seems to me: Trade partners regularly complain about Germany’s current account surplus and call for measures to reduce it, whilst in fact, it is in Germany’s own long term interest to reduce it by making the necessary investments to secure a strong future, especially in light of a declining population.


Notwithstanding this challenge, having de facto established itself as a leader of Europe since 2010 – if not by design, then by default – Germany now has a clear opportunity to step up on the global scene. It may not be a leader in the field of international security and possesses few natural resources, but its economic success, ideas and ideology give it strong agenda setting power.


To paraphrase Varys, the Machiavellian eunuch, when providing some advice to Tyrion, the hand of the King and a dwarf, in ‘Game of Thrones’, ‘Power is a curious thing, my Lord. Power resides where men believe it resides. No more and no less. It is a shadow on the wall. And sometimes a small man or nation can cast a very large shadow.’ Germany’s growing shadow may now give it the confidence to invest in infrastructure and capex to support and even enhance its standing on a long term basis, both economically and politically.

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