Going nowhere fast

As Germany slides toward recession, writes Eddie Ford, indefinite stagnation seems to be on the cards for the euro zone - which is bad news for George Osborne

With the media’s attention focused on the Middle East and elsewhere, you could almost overlook the fact that the euro zone is still in crisis and seems in danger of entering a deflationary spiral. This has fuelled increasing speculation about the ‘Japanisation’ of the euro zone economy: wobbling in and out of recession and an inflation rate that registers below zero and therefore an incentive not to buy.

No wonder then that the October 10-12 International Monetary Fund-World Bank meeting was dominated by gloomy talk of a generalised economic slowdown. Yet again, both bodies lowered their forecasts for global growth next year. Olivier Blanchard, the IMF’s chief economist, said the recovery was “weak and uneven” and predicted 3.3% growth - 0.4 points lower than anticipated in the spring. In fact, the IMF is feeling especially downbeat - saying in its latest economic outlook that the euro zone now faces a “four in 10” chance of re-entering recession within 12 months, along with a 30% chance of outright deflation.

However, the IMF’s fears run even deeper. Blanchard admitted it was “entirely possible” that the developed countries will never return to their pre-crisis growth levels: a big chunk of economic production has been permanently lost. We are now entering a period of secular stagnation - ie, there has been a structural decline in potential growth rates. And the achievement of even these lower rates of expansion - one of the more optimistic scenarios - would require interest rates to be maintained at historically low levels over a lengthy period, and that brings its own problems, of course.

Yes, rock-bottom interest rates, combined with quantitative easing, has generated copious amounts of cheap money. But it has not done what was intended, which was to reawaken the animal spirit in capital and hence encourage investment - that in turn would power economic growth. Rather, delighted speculators have had casino chips stuffed into their hands. Or, in the words of the IMF’s financial counsellor, José Viñals, we are facing a “global imbalance” - with “not enough economic risk-taking in support of growth”, but instead “increasing excesses in financial risk-taking” that are “posing stability challenges”.

The euro zone now seems stuck in a vicious loop. As the financial markets expect only extremely limited interest rate rises, there has been a massive turn to speculation. Consequently, there has been a steady blurring of the line between ‘safe’ and ‘risky’ investments and, completely contrary to plan - though with its own remorseless logic - investors have been ploughing money into all manner of shady schemes, just like they did before 2007.

Obviously, central bankers know this only too well, but feel powerless to do anything about it - hiking up interest rates would just tank the economy in next to no time. In which case, just cross your fingers and hope, Micawber style, that everything somehow turns out for the best. A near perfect recipe for never-ending crisis, in other words.


Naturally, the bleak assessments coming out of the IMF prompted a big sell-off in the financial markets. After peaking in September, the FTSE 100 index marked its third successive daily drop by falling 1.4%. At the same time, Germany’s Dax dropped 2.4% and France’s Cac went down 1.6%.

Finland, meanwhile, was stripped of its ‘gold-plated’ triple-A credit rating on October 10 by Standard & Poor on the fairly logical grounds that the country could suffer “protracted stagnation”, thanks mainly to its double “exposure” to the euro zone and the ailing Russian economy - after all, exports to Russia account for about 4% of Finland’s total economic output.1 On the warpath, S&P also cut its outlook on France from ‘stable’ to ‘negative’ and warned that it ran the risk of a further downgrade of its current credit status, reduced only last November from AA+ to AA. Fitch followed suit four days later - both agencies expect the French economy to “deteriorate” beyond 2014 (leaving only Germany and Luxembourg for the time being with a pristine triple-A score).

Showing the turbulent state of the markets, the Vix volatility index or ‘fear gauge’, jumped 8% to its highest level since December 2012. As a result of such statistics, US investors took fright - nothing they hate more than uncertainty - and started liquidating their European holdings at a fast rate. Indeed, last week saw the biggest weekly outflow in two months. According to Lipper data,2 total European assets dropped from nearly $50 billion in June to $40 billion - a significant wipe-out. Accordingly, as sure as night follows day, US government bond yields slid to fresh lows - reflecting this growing investor unease over signs of a deepening slowdown in Europe (yields fall as prices rise).

Nor is it just the euro zone slowly going down the tube, of course. The Brics (Brazil, Russia, India, China and, laughably, South Africa) are visibly slowing down, even though we were constantly told by silly commentators that they represented our future - if not salvation.3 For instance, Brazil has entered a severe slump, its central bank now predicting GDP growth of only 0.7% this year; and Russia is being hammered by the continuing fall in oil prices. Things were already bad enough for the Russian economy, given that in April S&P slashed Russia’s rating to just one notch above ‘junk’ status, as investors - quite sensibly from their own viewpoint - continued to take money out of the country amid tensions over the situation in Ukraine: the Russian economy is now expected to grow at no more than 0.5% during 2014.4 Even China is suffering from a relative slowdown. Additionally, a pair of official surveys showed that China’s manufacturing sector held up in September, but remained “subdued” - possibly an indication that the economy is struggling, despite the recent introduction of a whole raft of governmental policies designed to encourage activity.


One obvious sign that the euro zone is going nowhere fast is the worsening performance of the German economy - the supposed powerhouse of Europe. Hit badly by the Russia/Ukraine crisis, its economy shrank by 0.2% in the second quarter, so a second consecutive contraction in GDP in the third quarter would tip it into recession, setting off alarm bells. The German government is expected to lower its estimates for GDP growth to 1.2% for both 2014 and 2015, from 1.8% for this year and 2% for next year - and the IMF has downgraded its growth forecasts for 2014 from 1.9% to 1.4% and for 2015 from 1.7% to 1.5%. More alarmingly still, German exports in August suffered the biggest monthly fall in more than five and a half years - down 5.8% compared to July, and much sharper than the 4% widely forecast by economists. The statistics also showed that imports fell unexpectedly too in the same month, sliding down 1.3%, even though a 1% rise was widely expected - so you could call it a double whammy.

Rather dramatically, Carsten Brzeski, chief economist for the ING group, described the current situation in Germany as a “horror story” and worried that the “magnitude of the fall” brings back memories of the 2007-08 financial crisis - the country would need a “small miracle” in September to avoid recession. Responding, a bullish Wolfgang Schäuble, the German finance minister, insisted that there was no recession in Germany but rather a “weakening of growth” - although it is worth noting that the yield on government 10-year bonds has actually tumbled to a record low of 0.837%.5 Paradoxically, but for eminently understandable reasons (just like when the US government was downgraded three years ago), investors took the economic bad news from Germany as a prediction for the global economy as a whole and started looking for a safe haven - most settled for the US, naturally, but a not insignificant number obviously decided to ‘relocate’ whatever remaining assets they had in countries like Italy or France to … yes, Germany, which for all its current economic woes looks politically and financially stable.

But, as we all know, if Germany gets a cold then the rest of Europe gets pneumonia. Any hope of a recovery in Greece, Spain, Italy, etc is dependent on German growth. The same is also true, of course, for Britain, seeing that half its exports go to the euro zone and if that is stagnating then George Osborne’s ‘plan A’ is going to stall as well - so there is absolutely no chance of Britain exporting itself into a glorious recovery before the 2015 general election. Even Osborne, famous for his economic illiteracy, has been forced to partially admit that this is a possibility. Speaking at the recent Washington summit, he stated that Britain cannot be “immune” from the European slowdown, which has already had an “impact” on UK manufacturing and exports - “more measures” were needed to get through the “financial turbulence” that possibly lies ahead. However, he declared, Britain needs to send a “clear message” to the world that it has a “stable economy” and is going to “weather those storms” - it was “not going to deviate” from its plan to cut business taxes and make the UK a place to invest. He also said “slower growth” had been “taken into account” by the Office for Budget Responsibility, which is forecasting growth of around 0.6% per quarter, compared with the 0.9% seen in recent months. In other words, despite all the pain, a growth rate of about 2% is the best it is going to get - nowhere near what Osborne promised in 2010 or even two years ago.

Everywhere we see evidence for the extraordinarily fragile nature of the British economy. On October 13 the US and UK engaged in a financial ‘war game’ to test the robustness of the financial system if a major bank on either side of the Atlantic goes bust. Short answer? No: the state would have to step in promptly to avert catastrophe. Interestingly, unlike with the domestic ‘war games’ conducted before the financial crash, Osborne ‘pledged’ to publicise the results - we are still waiting.



1. www.channelnewsasia.com/news/business/international/finland-loses-top-triple/1409056.html.

2. Which covers over 213,000 share classes and more than 117,000 funds located in over 60 countries and is a mutual fund rating system that uses investor-centred criteria such as capital preservation, expense and consistent return.

3. If that was not enough, the same person who created the ‘BRIC’ acronym - Jim O’Neill of Goldman Sachs - also coined the term, MINT: ie, Mexico, Indonesia, Nigeria and Turkey (http://tinyurl.com/m5l5z8b).

4. www.bbc.co.uk/news/business-27159423.

5. http://online.wsj.com/articles/u-s-government-bonds-stronger-on-continued-eurozone-weakness-1413294619.