Checking In On The German Economy

Germany, the 4th largest economy in the world, is seen by some to be the pole that holds up the Eurozone tent. The strength of the Eurozone depends in many ways on the strength of the German economy.

Luckily for Europeans and investors alike, German indices have lifted higher in 2015 due to the positive effects of quantitative easing (QE) by the ECB. The QE program has set the German market up for appreciation driven by the effects of the asset bubble QE creates.

The Case For Germany

In regards to quantitative easing, the ECB is carrying out monetary policy through the 19 central banks in this currency union. The degree to which a central bank acts depends on the weight of the country in the Eurozone, a process called risk-pooling via capital keys.

Since Germany is the strongest economy and holds the most weight, the Bundesbank is stuck with 26 percent of the policy burden, i.e. the German central bank is carrying out 26 percent of QE from within German borders.

Because Germany has such a large responsibility with QE, German bonds have been flying off the shelf faster than you can say “quantitative easing” by virtue of purchases by the Bundesbank. Yields have expectedly dropped in response to the policy, with the German 2 year descending below 0 to a paltry -26 basis points as of Friday the 24.

It's possible there will be inflation in the Eurozone, given the flood of money supply to the market from the central bank purchases. As seen below, since the ECB started QE in March, inflation in the Euro area and in Germany have both been trending upwards.

Germany’s inflation tends to lead the Euro area average inflation rate.

In March, Germany’s inflation was higher than the Euro average by 40 bps. If there’s one Euro central bank that’s wary of inflation, it’s the Bundesbank. 

The export-driven German economy has seen weaker manufacturing numbers as of late, which may be a cause for some to worry. German PMI is hovering around 50, representing a potential contraction of their manufacturing sector in the future.

However, QE has caused the Euro to rapidly depreciate against the currencies of the United States, United Kingdom, and China, which represent three of the four largest recipients of German exports. The devalued euro means that German goods are cheaper, people will presumably buy more from Germany, and we’re hoping German export and GDP numbers perform well as a result.

Grexit

Should Greece exit the Eurozone, it's reasonable to expect depreciation in the euro –- which may boost German exports –- and generally a weakness of the overall region. It may lead to peripheral countries such as Finland or Portugal leaving soon as well, or more defaults if Greece can’t pay its debt.

The larger economies likely want to maintain the consistency of the euro and the strength of the currency union, which is what makes a Grexit so precisely uncertain.

Germany is, however, one of the largest holders of Greek debt; it's possible the Germans would rather allow the debt to be written down before allowing Greece to exit the currency altogether.

Obviously, the possibility of the default of a sovereign state is never positive, but Greece only represents less than 2 percent of the Euro area GDP.

Special thanks to the author(s) of the Daily Shot, from whom I get most of my daily economic analysis, as well as Mike McCullough who humbled me in terms of my knowledge of the Eurozone.

Image credit: Public Domain