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One step away from recession and a \new austerity\

2022-05-05 | EU

Germany's famous economic powerhouse flounders. Rising rates push the US into recession. Central banks start to look warily at the housing market again. And the "new austerity" is taken for granted so naturally in France and Spain that its implementation depends only on the timetable of the elections.

The collapse of the German model

German foreign trade

German foreign trade

In the graph above we can see the evolution of German foreign trade. In the first quarter of 2020 there was a brutal drop: the pandemic confinements. But from the following summer onwards the export recovery is solid... until the war in Ukraine. Then imports grow faster than ever and exports fall.

This is the direct result of sanctions: exports are blocked but gas and oil and gas are still on the rise. The result: the famous German trade surplus, for the first time in decades, shrinks to the point of almost disappearing.

This is no temporary phenomenon. The USA - and quite a few countries within the EU - are urging Germany to break off its relations with Russia and China once and for all. The same people who praised the "German model" and its export strength are now decrying the fact that it was based on cheap Russian energy, complementarity with China and a euro zone that was always useful for keeping total labor costs low. So they push Germany towards an "independence from Russia" which means nothing other than the scrapping of its industrial export sector.

While Germany's allies are tightening the noose around the neck of its industry, German capital is trying to buy time and use it, at full speed, to find alternatives. At the moment this is all about racing to build floating LNG terminals - which will further raise production costs by substituting Russian gas with American and Qatari gas - and "reinvent China" in India or the Balkans.

In themselves, both moves are nothing new. Germany is the leader of the European Green Deal because the change of energy basket was its strategic bet to recapitalize and revive its industry. It has also been the country most eager to integrate the Balkans into the EU because it saw in them a "safer" and more profitable alternative to the internationalization of production in Asia. But the German rulers gave themselves more than 20 years to get both things done. And now both the US and the EU are denying them that margin.

The impact on workers of inflation and poor expectations in the export sector is being immediate. So much so that the Scholz government has presented a real social emergency plan to stem the tide: salaried workers will receive €300 gross to compensate for high energy costs, the €9 monthly ticket for local and regional transport will become valid for three months, and the child allowance will be increased once by €100 per child.

The speed and focus of the response says it all about the fears of German capital. They fear that when this is coupled with a more than foreseeable global recession in a matter of months, it will set in motion a class militancy that is already awakening.

U.S. on the road to recession

Federal Reserve interest rate

Federal Reserve interest rate

Polls show that 64% of Americans are unhappy with the Biden administration's economic management. Wages have been pillaged by inflation for many months now... and the Fed's response is not going to make it any easier for them. Today the Fed raised interest rates in one fell swoop more than ever before since 2000. This will likely mean a drop in the pace of hiring - which was already weakening badly - and a loss of average wage purchasing power.

Normally, when rates rise, speculators consider that, with higher rates, companies with lower investment capacity and higher financial costs will give worse results and revalue more slowly; banks will sell fewer loans and will have more defaulters; and construction companies will have less demand for housing because mortgages are more expensive. In other words: rising rates, falling stock market. But today the opposite happened. Practically everything went up, starting with banks and construction companies. To that extent, the monetary policy mechanisms and "the markets" are already broken.

Not that the outlook was particularly good until yesterday and any damage to demand caused by the rate hike was considered anecdotal. On the contrary: home sales had already fallen by a spectacular 7.2% in February, accompanied by mortgage interest rates that were already very high (5%) and prices per square meter that are the highest in the country's history. With those prices and those mortgage costs, workers were practically driven out of the market. Now even more so.

In short: to stop inflation from eating away at wages, the Federal Reserve is going to force a recession that will further weaken hiring. There will be fewer and lower paying jobs. The vaunted "recovery in consumption" will not be forthcoming.

The European housing market

Banks' exposure to mortgages by countries

In Europe, housing is also setting off alarm bells. Economic press reports already reflect what is a daily conversation: housing prices are soaring in the Netherlands, Denmark, Sweden... not to mention Germany, at an all-time high, or in Ireland where the continuous rises are in double figures. The Bank of Spain, although it denies serious "imbalances", is already on guard.

Not surprisingly, according to the latest report of the European Systemic Risk Board, the housing market suffers from high overall risks in a dozen countries. Despite stagnant GDP, in the second half of 2021 not only did house prices rise, but the rate at which prices are rising increased. And the spiral is not stopping.

Across Europe, mortgage lending as a percentage of GDP is already higher than it was before the pandemic. And in some of the most problematic countries, including Germany and the Netherlands, new mortgage lending flows are double those of other countries.

In Germany and Slovakia, the countercyclical capital buffer was activated, which means requiring banks to hold more capital to support the loans they grant. Other countries have tightened the criteria for granting mortgages. The situation is worrying regulators.

No wonder: as we can see in the graph above, the average exposure of European banks to mortgages is more than 25%, and in the Nordic countries, Portugal and Poland it is around or exceeds 35%. In the context of an ongoing recession, the risk of a wave of mortgage defaults fueling a financial crisis is to be taken seriously.