Europe’s economy is teetering on the precipice of deflation. Yesterday’s news that the UK consumer pricing index rose by only 1.2 percent (the lowest in five years) was accompanied by news that France’s prices were growing at only 0.4 percent, while Spain and Italy’s price growth had dropped into negative territory.
German factory orders dropped sharply last month in a departure from expected forecasts. The Financial Times reports:
Factory orders fell 5.7 per cent in August compared with the previous month, the biggest drop since January 2009 when demand slumped in the aftermath of the global financial crisis[…]Worries over developments in Russia and Ukraine, a slowdown in China and deflation in the eurozone have dented confidence in recent months. German GDP fell 0.2 per cent in the three months to June, compared with the previous quarter.Demand for German exports fell 8.4 per cent in August while investment goods orders fell 8.5 per cent compared with the previous month.“It doesn’t bode well for industrial production in the fourth quarter to be honest,” said Carsten Brzeski, chief economist at ING-DiBa. “What was worrying with the order data is that it was across the board. In Germany many commentators love to blame everything on Putin but it’s more than that.”
The “more than that” has grown to include an impending European boxing match between Paris and Brussels that highlights the economic weaknesses of Germany’s neighbors. The European Union is poised to reject France’s proposed 2015 budget that openly defies the EU’s agreed-upon limits upon France’s sizable deficit. Germany’s economy is now linked to its Western as well as its Eastern neighbors; since the European Union promoted a currency union before a corresponding political union, it is unlikely that Germany’s Western problems will go away any time soon.Doctor Hans-Werner Sinn, president of the prestigious Ifo Institute for Economic Research, diagnoses French malaise in a recent interview with the Telegraph:
France is the socialist country of Europe, if not the world, because among the OECD countries, it has the second highest government share in GDP after Denmark. Neither the Danish nor the French economy work very well, they have an overgrown government sector which is 10 percentage points more than the German one, for example…The [French] people who were set free from manufacturing, or their children, have by and large been absorbed by the government sector, which has now a quarter of the workforce, twice that of Germany. Hiding the unemployed in government offices is not a healthy solution.
The attached graph further illustrates Sinn’s point. Le modèle bleu is alive and well in France while the industrial base that once supported it is moribund. To his credit, the French Prime Minister Manuel Valls has focused his recent attention on this growing impasse. Valls has filled his cabinet with center-left Young Turks who flirt with pro-business strategies that encourage growth. Yet he faces determined opposition within his own market-phobic Parti Socialiste that may hamstring his ability to implement any meaningful reforms.Valls’ business-friendly rhetoric, if it translates into action, may be France’s best short-term hope to sidestep the pending Eurozone conflict. It’s the best solution for Germany, too. Europe’s fiscal union has connected German manufacturing receipts to global events in Athens, Paris, and Kiev. But betting on things working out in Europe in any definitive way has been a losing proposition for several years running. We have seen these standoffs before, and they have always been resolved by kicking the can down the road in one way or another—adding another layer of eurofudge, if you will, to an already teetering mess of a cake. The only difference this time around is that economic pain is being felt more broadly than before. Can it be enough to make this time different?