Obamaitis? That’s not Why I’m Worried about Germany

What a week that was! Her Majesty the Queen turned ninety. The Bard passed away exactly 400 years ago. St. George’s Day last Saturday coincided with the Master Investor Show, which was a sell-out. And then Obama turned up, wished the Queen Happy Birthday, told us to get to the back of the queue and then buggered off to Germany.

I have been reading the new book[i] by that anti-austerity rock star economist, Yanis Varoufakis – which I have reviewed for next month’s MI magazine. He has some quite stringent observations about America and Germany. America devised the global monetary system founded at Bretton Woods in July 1944, which lasted until President Nixon pulled the plug on it in August 1971. Germany devised (with a little help from the French) the architecture of European Monetary Union (EMU) and continues to sustain it. Both nations were able to construct international currency systems with themselves at the centre because they were running massive trade surpluses. At the end of WWII America accounted for around one third of global GDP and she continued to run surpluses until the 1960s – since when she has never been out of the red. The Germans have continued to run surpluses since they were able to re-launch their industrial base just after the War. Last year that trade surplus amounted to 8.8% of GDP[ii].

Just remember one historical fact: the Americans forgave the Germans their debts after WWII and, instead of imposing reparations as after WWI, offered the Germans the Marshall Plan which provided massive capital injections to rebuild German industry. At a time when bankrupt Britain, skin-flint after being the only nation on earth to have been in total war from 1939 to 1945, bombed to smithereens, was ordered to dismantle its empire while investment languished to zero at home. Growing up in South London, I can still remember the endless bomb-sites which endured until well into the 1970s. I thought desolated vistas were normal. Not only did Britain mortgage much of the Empire to the USA in the early stages of the War under “Lend-Lease” but the Americans printed Dollars and then lent them to HM Government at a commercial rate. Interestingly, the last instalment of war loans was paid back to the USA by the British government during the Iraq War in 2003.

The main reason why Britain had become The Sick Man of Europe by the time that Margaret Thatcher came to power in 1979 was that Britain’s industry and infrastructure had been starved of investment for nearly four decades.

We lost the War. In fact we lost almost everything – something I often think about when I visit Chartwell (Churchill’s country home), as I do every spring, just down the road from where I live in Kent. And, in his dotage, the Old Boy knew it too.

The Russians won the War – and deserved to do so, given their massive expense of blood. And the Americans won the peace, emerging as the very pivot of the global financial and monetary system (which excluded countries in Russia’s orbit, be it said). There was no peace conference after WWII like the Versailles Conference of 1919 after WWI. The world just had to adapt to what was agreed at Yalta, where Stalin famously winked at FDR while Winston napped.

Under Bretton Woods, all nations’ currencies were pegged to the Dollar which was itself exchangeable for gold at a rate of US$35 per ounce. The system worked hugely to America’s advantage while the US still generated a trade surplus. But by the 1970s the Americans had a trade deficit and, thanks to the Cold War, the Space Programme, President Johnson’s social programmes and the Vietnam War, America was running a colossal budget deficit as well. These twin deficits have effectively been financed automatically by foreigners (latterly the Chinese) ever since because the US Dollar has remained the international reserve currency – and the currency in which all major commodities are priced.

Now all this has got me thinking about the fate of Germany. Could its being the centre of a currency union, which (I am not the only one to say it) is failing, pose dangers for German prosperity? Or, is Germany immune to the stresses on its periphery? Remember that, while the Fed has been able to finance twin deficits indefinitely by printing Dollars, the Germans opposed ECB President Mario Draghi’s programme of quantitative easing because they considered it inflationary. Ultimately, the Germans have surrendered their control of monetary policy to the ECB, as has France and the rest.

Well, if stock markets are accurate predictors of trouble ahead, then the DAX might give us cause for concern about Germany. It fell by about 23% between early December last year and mid-February this year, since when it has recovered about half of those losses. But that rebound disguises the fact that some of Germany’s most iconic stocks have performed miserably this year. In particular, take a look at the German automotive sector – the very bedrock of the German economy and those enduring trade surpluses – and the banking sector, which in my view is often a bellwether of where the economy as a whole is going.

When the scandal erupted last year at Volkswagen AG (FRA:VOW) – the veteran German car-maker eventually admitted that it had falsified emissions data – it was not clear whether this was some one-off scandal or evidence of a deep, systemic crisis in German corporate governance. With the admission by Mitsubishi Motors (TYO:7211) on 26 April that it has been cheating on fuel mileage tests for the last 25 years[iii], it is now clear that this is not a uniquely German problem. What other big names in automobile production may be up to these tricks is anyone’s guess. But it is fair to say that the reputation of Germany’s industrial leaders for punctilious integrity has taken a severe blow. VW will probably take years to recover from this sorry affair – the legal consequences in the USA are only now becoming apparent – but in the meantime its share price has floundered, being down 40% on one year ago.

The one-year chart for Daimler AG (FRA:DAI), implicated in the VW scandal, is also a sorry picture. Daimler AG, which owns the constellation of vehicle brands around the Mercedes-Benz logo, has lost one third of its value. And there could be more bad news to come. Last week the US Department of Justice (DoJ) announced that it would further probe Daimler’s diesel emissions data. The share price is under pressure even though earnings data released on 25 April was ahead of analysts’ expectations ($1.42 per share against the average estimate of around $0.70).

If automotive stocks are under pressure, German bank stocks are dire. On 28 April Deutsche Bank (FRA:DBK) announced that Q1 2016 was “one of the most difficult ever”. It gave investors little hope of a happy 2016. The bank announced in February that it had cancelled its dividend for this year, which, as I explained in the March edition of MI magazine[iv], is the kiss of death for bank stocks right now. (Barclays endured the same treatment recently.) Deutsche Bank (the clue is in its very name) is a lode-star for the German economy. And its share price has fallen from nearly €32 at the beginning of July last year to €16.84 at midday today (29 April). So investors have lost half their money in 10 months. That is serious bear territory. And then there is Commerzbank AG (FRA:CBK), whose share price has fallen a mere 34 percent over the last year.

What these German automobile makers and banks desperately need is a return to interest rates that reflect the supply and demand for money in the system – in Keynesian terms, a rate which sets savings and investments in equilibrium. But, because the Eurozone is mired in debt and deflationary pressures abound, Germany finds herself with zero (and even negative) interest rates. The one-size-fits all monetary policy implicit in European Monetary Union is now beginning to squeeze even the Eurozone’s biggest economy and paymaster.

Hitherto, the Germans have considered themselves fortunate to be amongst the greatest beneficiaries of EMU. After all, they could continue to export their manufactures to the rest of Europe without boring old exchange rate risk and transaction costs. I foresee that the Germans, with their deep philosophical rigour, will begin to question this assumption.

And another thing. President Obama has made much of his cordial relations with Frau Merkel. But he is now a lame duck. A President Trump (those words together at last, if still only conjectural) would tell Frau Merkel, in no uncertain terms, that the Germans have to pay for their own defence and not rely on Uncle Sam to pick up the tab in perpetuity. That would entail a perhaps four-fold increase in the German defence budget which would impact the country’s fiscal policy mightily.

And I note that the DAX plummeted on Monday with Mr Obama’s arrival in Hanover just as the FTSE fell in London last Friday with Obama’s back of the queue outburst. I think you will find that markets fall wherever he goes, though natürlich, correlation is not causation. I call this Obamaitis. But that’s not why I’m worried about Germany.

[i] And The Weak Suffer What They Must? Europe, Austerity and the Threat to Global Stability, by Yanis Varoufakis,  Bodley Head, 2016

[ii] See the graphic on Trading Economics at: http://www.tradingeconomics.com/germany/current-account-to-gdp

[iii] See: http://www.theguardian.com/business/2016/apr/26/mitsubishi-admits-cheated-fuel-mileage-tests-25-years-nissan

[iv] See my article on European banks, available at: http://masterinvestor.co.uk/economics/european-banks-please-assemble-at-the-muster-station/