Berlin’s Maddening Aversion to Fiscal Stimulus: A Traders’ Guide

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(Bloomberg) — Over the past decade Germany has saved like few other nations, slashing its debt from 83% of gross domestic product to 60%. But now the global economy is slowing, there’s talk of recession in Berlin, and institutions like the IMF are calling on Chancellor Angela Merkel to loosen the purse strings and to keep Europe’s economic engine going.

Investors had better not hold their breaths. The Germans have a complicated relationship with deficit spending.

Why isn’t the government ramping up spending already?

That’s not what Germans do. They are fiscally conservative people with a deeply-entrenched culture of saving and a fear of inflation — remember those wheelbarrows of marks from the 1920s? The Berliners do.

Leaving sound public finances is one of Merkel’s key objectives. Sure, she announced the largest stimulus package in Germany’s post-war history in 2009, but that was with the economy collapsing by more than 5%. Even then she said it was the toughest decision she had ever taken.

This year, GDP is forecast to grow 0.6% and Merkel and her Finance Minister Olaf Scholz have insisted they will stick to a balanced budget and that there are sufficient funds to finance necessary investments. On Tuesday, the chancellor offered the first hint of movement.

There’s no need for stimulus “so far,” she said. But the government will “react depending on the situation.”

So what could she do?

It’s actually not so easy.

In response to the 80 billion-euro ($89 billion) package she unleashed in 2009, parliament adopted a constitutional limit on borrowing. So net federal debt can increase by only 0.35% of output while the economy is growing.

In a recession, the rules are relaxed. The worse it gets, the more the government can borrow, but even then it’s not much. A 0.5% contraction would free up an extra 3.5 billion euros. Bloomberg Economics estimates that it would take at least 1% of GDP, or about 30 billion euros, to undo the damage caused by the slowdown over the past year.

Why is the issue back in focus?

Germany’s economy grew over 2% in 2016 and 2017 but has now come to a virtual standstill. It contracted by 0.1% in the second quarter and some economists say the next three months could see a recession take hold.

The International Monetary Fund and the U.S. government have urged Berlin to boost spending and cut taxes. European Central Bank chief Mario Draghi also weighed in, saying that governments will need to play a bigger part in aiding growth with fiscal stimulus in the next downturn.

That argument is finding support in Germany, with some business and political leaders arguing Merkel should act to avoid a recession not to pull the economy out from one. They point out that with even 30-year bunds showing negative yields, the government would be paid by investors to borrow.

So is there any way around this?

The government could seek to circumvent the constitution by using or creating quasi-government agencies or companies, such as Deutsche Bahn, to issue debt and spearhead investment plans.

The debt brake does allow for significant deficit spending in exceptional circumstances, but that would require the parliament to declare the economy to be in crisis. The Social Democrats, Merkel’s coalition partner is also calling for spending constraints to be lifted to ramp up investment in climate protection and the Finance Ministry is planning to introduce so-called green bonds.

The real wild swan though is the Green Party.

The Greens are polling close to 25% in recent polls, within touching distance of Merkel’s Christian Democrats. Were they to overhaul the CDU in the next election, due by 2021, that would be a game changer.

The party is calling for massive investment in climate protection that could mean abandoning the balanced budget commitment. But that would be too late to avert the current slowdown.

What should investors watch for?

Merkel this week showed the first signs of wavering in her opposition to stimulus and the chancellor remains the key player in German politics. The budget debate from Sept. 10 may offer further clues as to whether pressure is growing.

Beyond that, the third quarter GDP numbers will be key. A second successive contraction would unlock some of the financial firepower that the constitution keeps out of the politicians’ reach.

Real shock and awe remains a long shot. But keep an eye on those poll numbers to see if the Green revolution can gather any momentum.

To contact the reporters on this story: Birgit Jennen in Berlin at bjennen1@bloomberg.net;Raymond Colitt in Berlin at rcolitt@bloomberg.net

To contact the editor responsible for this story: Ben Sills at bsills@bloomberg.net

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