The Fickle Fall of Frau Merkel


How quickly the mighty fall. Just this summer the Germans appeared to be on top of the world. Dominating the Eurozone economy, offering Calvinist lectures on fiscal responsibility to the Greeks and still basking in the afterglow of their World Cup win. Nothing seemed to dent their arrogance and the world assumed that if Europe was ever going to pull out of its quagmire – Germany would lead the way.

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But in markets as in life, change comes quickly; and the former Greek finance minister Yanis Varoufakis must now be looking at the current German situation with no small sense of schadenfreude. Just a few months ago, the German economy looked like fortress of steel but now it is riddled with more holes that a piece of Swiss cheese.

First there is the Russians. Last year’s invasion of Ukraine soured the relationship between the two giants of Europe and the decline in oil prices only exacerbated the situation by slicing Russia’s primary source of income in half … greatly reduced its demand for German goods and services.

Bleak Outlook for Brand New BMWs, Audis and Mercedes Benz

Then came the Chinese. The blow up in Chinese equity market wiped out a lot of new-found wealth, and suddenly, the demand for all those shiny new BMWs, Audis and Mercedes Benz looks much more precarious as we approach the year end. Add to that the fact that Chinese construction industry has taken a dive and all those German equipment sales are likely to be pushed off well into the future.

Next came the refugee crisis. The horror in Syria has created the greatest migration of war torn civilians into Europe since World War II. Much to the honor of the Germans they have welcomed those fleeing the war zone with open arms. Unlike many of their European neighbors, the Germans are allowing more than a million refugees to take shelter in their country. While this is an inspiring human rights story, it is also sure to burden the German welfare state as it tries absorb so many people in such a brief period of time.

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Volkswagen’s Latest Emissions Scandal Hurts More Than the Environment 

But perhaps nothing has hurt the German economy more than VW scandal. By now everyone in the world knows that VW sold more than 8 million diesel engine cars that cheated on their emissions standards… spewing more than 50 times the allowed standard of pollutants into the atmosphere. The ramifications of this disaster are staggering. Not only has this scandal destroyed a massive amount of goodwill towards German industry – but it has created a huge financial problem for the German economy as a whole.

VW is Germany’s largest employer with more than a quarter of a million workers in its immediate workforce. Its power however radiates far beyond the corporate walls. As we write this the VW board is in the midst of an emergency meeting desperately trying to come up with a fix. Analysts estimates have ranged from as little as 100 euro per vehicle, to as much as 10,000 euros if new engines are needed. At that point, it may be simply easier to give customers new cars. UBS analysts have forecast that the total bill for this fiasco which includes fines, lawsuits and repairs could add up to 35 billion euros.

The VW news has already had a chilling effect on the German economy. After nearly a year of monthly declines, German unemployment has started to rise notching increases in two of the past three months. Given the near certain prospect of layoffs at VW that unwelcome trend is likely to continue. German Industrial Production is faltering as well as it contracted by -1.3% this month versus 0.3% expected rise.

All of this is bad news for the euro. The currency has been remarkably resilient, holding its own against the buck as the combination of a hesitant Fed and wobbly equity markets helped keep the bid underneath the single currency. However, that strength cannot last. As Germany slows down the ECB will almost certainly be forced to pump more money into the system, increasing its QE program in order to stave off a possible recession in Eurozone’s largest and most important economy. The ever widening policy divergence between the ECB which will keep issuing credit and the Fed which has already started to curtail its own balance sheet will finally makes its presence felt on the EUR/USD exchange rate,

They say that human beings are built to withstand stress. It’s only when we face a preponderance of stressors all at once that we begin to crumble. Economies are much the same. Germany now faces assault from all sides and this time Angela Merkel may not be able to avoid a contraction that could drag the rest of the Eurozone down with it and take the EUR/USD rate back towards its multi year lows of 1.0500.

Until next time,

Boris Schlossberg

Mr. Schlossberg is a weekly contributor to CNBC’s Squawk Box and a regular commentator for CNBC Asia and CNBC Europe. His daily currency research is quoted by Reuters, Dow Jones, Bloomberg and Agence France Presse newswires and appears in numerous business publications and newspapers worldwide. Mr. Schlossberg has written articles on trading for SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is the author of Technical Analysis of the Currency Market and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game, both of which are published by Wiley. Boris’ extensive experience in trading and developing momentum based techniques provide the foundation for BKForex’s strategies.