France and Germany lead the West out of recession
Germany and France have become the first of the major G7 powers to emerge from the Great Recession of 2008-2009, surprising markets with growth of 0.3pc in the second quarter.
Published: 8:34PM BST 13 Aug 2009
Signs of recovery in a region of critical importance to British manufacturing is a bitter-sweet development for Gordon Brown, who can no longer claim that the UK is weathering the crisis as well as core Europe. The British economy contracted 0.8pc over the same period, despite the prop of a much weaker pound.
Shadow Chancellor George Osborne said the contrast in fortunes on each side of Channel was an indictment of this Government. "It is striking that the economic data for Britain has shown a continuing sharp contraction in recession," he said.
Car scrappage schemes in France and Germany and the "automatic stabilizers" of their welfare systems have helped put a floor under the downturn, while near-zero market interest rates and emergency lending by the European Central Bank has stopped credit drying up. Crucially, neither country went through the sort of extreme debt bubble seen in Britain.
Germany's economy minister Karl-Theodor zu Guttenberg said it was too early to tell whether the recovery is firmly entrenched given the surge in unemployment expected over the next year. "There are no grounds for euphoria. It is going to be a long slog to get our economy back to the level it was at last year."
Germany's economy suffered a cliff-fall over the winter as world demand for cars and industrial machines collapsed. Output is still down 5.9pc from a year ago.
Officials are concerned that the economy may stall later this year as companies exhaust a scheme known as Kurzarbeit that pays them to keep idle workers on their
books. The key German institutes expect unemployment to rise another million to 4.5m by late 2010.
Jennifer McKeown from Capital Economics said the spare capacity in the eurozone is "huge and rising". Companies will be forced to retrench further.
The equity markets largely shrugged off the good news. Bourses rose just 0.5pc in Paris and 0.9pc in Frankfurt, perhaps because the broader picture in the rest eurozone is still grim.
Spain's contracted 0.9pc and Italy shank 0.5pc, leaving an ever wider gap between the eurozone's North and South. Parts of Eastern Europe remain trapped in depression. Output over the last year has fallen 23pc in Lithuania, 18pc in Latvia, 17pc in Estonia.
The recession is far from over.
My current concern is that a negative feedback loop has already begun in most of the world's major economies.
Consider this (from Investopedia):
A relationship between an economy's GDP gap and the actual unemployment rate.
Investopedia explains Okun's Law
The relationship is represented by a ratio of 1 to 2.5. Thus, for every 1% excess of the natural unemployment rate, a 2.5% GDP gap is predicted.
So the danger is that we can quickly face a structural and growing unemployment problem. As time goes on, with sub 2.5% GDP growth, unemployment continues to get worse. At 0 to 1% GDP growth, unemployment increases at 1.5 to 2% per year. So 10% unemployment quickly becomes 12 or 14% unemployment.
With higher unemployment, savings activities increase and spending decreases which reinforces the negative feedback loop. Employers become even more defensive and cut staff further to protect the bottom line which in turn, increases unemployment further. Then house prices and other asset prices begin to drop as more supply enters the market.
This can then trigger a deflationary spiral.
Governments and central bankers fear this the most and want to avoid it by printing more money (technically Quantitative Easing).
Of course, the problem with government interference through additional borrowing and "stimulus" is the unintended distortions it creates in the market that delay the economic healing process.
Soon government borrowing power will be at its upper limit, as with all borrowers, there are limits to leverage.
The bond market will not allow borrowing" ad nauseum" without insisting on higher rates.
Contrary to what some in public office have claimed, deficits do matter. Even with the power of taxation, the state must reduce borrowing once deficits rise above 12% of GDP.
To continue to borrow (or print additional currency is borrowing if not longer an option) is to invite serious currency depreciation. That is when the situation becomes very interesting as an inflationary spiral can occur. In my view, this worry is well into the future.
My current strategy (you could say Strategy #4, as this has been an evolving process), is to increase my personal savings rate from 10% of monthly net income to 25%. With a growing amount of cash available, a person who saves will be in a strong position to weather a deflationary storm and make the most of investing opportunities even if unemployment knocks at the door.