Douwe Osinga's Blog: The Cost of Pessimism

Tuesday, December 7, 2004

Germany’s economy is in the doldrums. Has been for years and everybody knows why. The Germans work too few hours, the taxes are too high, the labor markets too inflexible. Add an aging population and you have yourself a nice crisis. Everybody knows. Everybody is wrong. Pessimism is the root of all evil in this case.


The other things listed are of course problematic too. But except for the aging, things have been like that in Germany for a long time and mostly they used to be worse. People say that German companies can’t compete in these circumstances, but if that was the case, you’d see expect German companies to struggle when it comes to selling their stuff abroad. Instead Germany is exporting more than ever. German companies are competing great. Economically, the trouble is that the Germans just don’t buy enough and the public consumption is shrinking.


Now in the greater scheme of things, everything of course is connected, but the main cause of it all is a lack of consumer confidence. Compared to the Americans, the Germans see things much bleaker and therefore save more and consume less. This isn’t new either; Germans have always saved more than the Americans. But when markets were less open,  the money they saved was directly invested in the local industry, who had thereby a lackluster home market, but access to cheap and abundant money. Now a lot of those savings are invested in the US, where the predominant optimism suggests that there is an opportunity for profit on every corner.


It’s not just Germany of course. The same thing is true if to a lesser extend for all of Europe. Japan is much like Germany, i.e. low consumer confidence, high savings, lots of exports and low growth. The rest of Asia is not quite there; currency movements are usually restricted, so the low savings don’t all flow away; The central banks of South Korea, China, Taiwan and others, however, buy American treasure bonds on a huge scale to keep the local currencies pegged on the dollar. This effectively means transferring a lot of the savings of their population to the US against a record low level of interest.


Meanwhile, the US economy powers through and advisers in Washington wave away the huge imbalances in the economy, saying that the market just allocates capital the most efficient way possible and that happens to be the US, 6.5% deficit be damned. Analysts are talking up US companies. Meanwhile the US economy is booming on borrowed money. But this Great Game will of course end in tears.


See the Washington advisers are right. But the market is sometimes a little slow and when it is slow it tends to overreact. At some point the whole setup will unwind. Some Asian country will think the dollar might drop even further and they’d better cut their losses by selling the treasure bonds they have now. That of course will make the dollar drop even more, which will trigger sales with by the other countries, who don’t want to be the last to sell. The drop of the dollar will force interest up and pop the housing bubble in the US. Cheap mortgages will suddenly become unaffordable and both consumer confidence and spending will plummet.


The Euro will reach levels where that will kill the export industry, the one sector that kept the economy in Euroland afloat. Cheaper imports and a flood of money looking for saver investment than the US will mean that inflation will drop below zero. This deflation will further undercut consumer spending and force the economy.


Or may be it all turns out well. But somebody should do something about this pessimism before it is too late.