At this time of year, after several months of snow and freezing rain, Canadians typically begin to worry about the effects of all of that road salt on their vehicles.
Similarly, there was evidence, this week, that the corrosive effects of economic weakness that have been eating away at the periphery of the euro zone for the past several years is causing structural problems with the drive train. It is difficult to put a good spin on the single currency area’s growth in the fourth quarter, which contracted by 0.6 percent. The figures reveal widespread weakness, with the economies of Germany, France and Italy all shrinking along with the “usual suspects” in the periphery. (The news from Japan, also, was not encouraging.) If there is any reason for hope, it is that these were the initial “flash” estimates, which are subject to revision. That said, it is difficult — nay, virtually impossible — to come up with a plausible scenario under which possible revisions would be large enough to change the basic message of broad-based weakness. And, while some market participants confidently predict a V-shaped recovery for Germany, this too is difficult to justify. After all, to this point, German growth had been supported by the strong recovery of the emerging market economies and, ironically, the near-death experience of the euro.
For much of the past three years, fears of Greece’s exit from the euro zone and continuing monetary dysfunction weighed on the euro, making German exports very competitive in global markets. The rest of the euro zone might have been in crisis mode, but Germany was doing rather nicely, thank you. However, with a master plumber of the financial system (hat tip: JA), Mario Draghi, now in charge of the ECB, the leaks in the single currency have been patched, an aggressive new policy stance in Japan that has led to a depreciation of the yen, and growth in emerging markets down significantly, it is not clear that German exports will be the engine of growth that they were over the past several years.
So, if the German economy is contracting (along with France, Italy, Holland, Austria, Portugal, …), the emerging economies are growing at a more moderate pace, and the U.S. faces the effects of budget sequestration, from where will growth come? The danger is that all countries will want to grow through net exports (exports minus imports). Needless to say, that is a logically impossibility. And, if you can’t grow exports because others are slowing, stagnating or contracting, the temptation might be to reduce imports. This is easily done if you are prepared to introduce tariff and non-tariff barriers. Of course, such actions would be inconsistent with international obligations. But the bonds of international cooperation, which seemed so strong at the height of the crisis as G20 action prevented a catastrophic collapse, have been frayed by divergent growth paths and by the burdens of adjustment under which many advanced economies labour.