The German Growth Engine and China

According to data released this past Thursday, “German unemployment fell to its lowest level in two decades in April.” After years of running double-digit unemployment, the total number of unemployed fell below 3 million people for the first time since 1992. Germany’s economy benefited from the strong export of autos and other products. (NY Times 4/28/11) Their unemployment rate now stands at 7.1%. While this strong performance has raised concern regarding inflation, which this month was reported at 2.6% versus the European Central Bank’s target of 2%, it is clear that not only is the German economy on a separate growth path from the rest of Europe, but it is also traveling along a very different path than the United States, where earlier today it was reported that the first quarter GDP slowed to an annual rate of 1.8%. This decline followed an expansion of 3.1% in the fourth quarter of 2010. The confluence of bad weather and a huge increase in oil prices, based on the constant unrest in the Middle East, clearly contributed to this contraction. (NY Times 4/28/11) While most economists are hoping that this decline will reverse itself as the year progresses, I am concerned that if imported oil prices remain high in the second quarter and we continue, once again, talking about raising tax rates, we will find the U.S. economy slowing further than forecast. We seem to have forgotten why we did not raise the tax rates at the end of 2010.

The other real difference in approach to exports between Germany and the United States is that while the Germans took advantage of the weak Euro in 2010 to expand their export trade, particularly of autos to China, the United States went to great lengths to lecture the Chinese about keeping the Renminbi artificially low to increase their own exports. China has clearly been willing, until recently, to trade off a lower unemployment rate for a higher inflation rate. During the past quarter they have started to shift their focus and have raised interest rates in an effort to lower inflation. The more practical German approach has clearly worked to revive the German growth engine, which should help to improve many of the other European economies as long as inflation can be kept at approximately 2.5%. BMW, Volkswagen and Mercedes Benz are all posting record sales in China.

Would an inflation rate of 2.5% in the United States (excluding gas prices) help to revive a very dormant U.S. residential housing market? Until we revive the housing market our economic recovery will remain very fragile, particularly in the Sun Belt states, where unemployment remains at historically high double-digit rates. We also need to have an export strategy that takes advantage of the weak dollar and is tailored to the fastest growing economy in the world, China.