Sinking into a Recession: Economic Crisis Mounts in Germany

German Finance Minister Peer Steinbrück is a frugal man by trade. Keeping track of the country's money is part of his job description, while reducing its debt is his most important goal. He expects Germans to do their part by going along with drastic tax increases, and he wants his fellow cabinet members in Chancellor Angela Merkel's government to carefully control their spending.

Last week, Steinbrück felt the need, once again, to cast his protective net over his treasury. At issue was whether the Germany needs a comprehensive economic stimulus program to jumpstart the economy. The left-leaning Social Democratic Party (SPD) called for a spending package worth €25 billion ($37.3 billion), while Economics Minister Michael Glos, a member of the conservative Christian Democratic Union (CDU), argued in favor of tax cuts across the board.

With his characteristic directness the finance minister, who was against both proposals, set his opponents straight. Economic stimulus programs, he said heatedly, would "only increase the national debt and impose a higher financial burden on future generations." Steinbrück went on to speculate that the programs could end up consuming vast amounts of money without having any significant effects on the economy.

Steinbrück has prevailed -- at least for now. But his alleged argument in favor of frugality and economic rationality could prove to be a mistake when it comes to economic policy.

The financial crisis is still anything but overcome, and there is good reason to fear that yet another major bank or two could falter. And the world's stock markets are still in a state of upheaval. Since the beginning of the year, the 30 stocks that make up Germany's DAX index of blue chip companies have lost the unthinkable sum of €346 billion ($517 billion). The banking debacle has fueled fears of recession worldwide, while weaker nations like Iceland and Pakistan are already teetering on the brink of bankruptcy.

Even levelheaded economists are drawing parallels to the Great Depression of the 1930s. Central banks are flooding the markets with low-interest capital, and yet banks remain extremely reluctant to issue new loans, even for creditworthy projects. This, in turn, has led to companies putting their investment plans on hold and a growing feeling of uncertainty among consumers.

A movement has been put into motion that resembles the scenarios British economist John Maynard Keynes described more than 70 years ago in his "General Theory." Because trust has been essentially destroyed in the financial and credit markets, banks, companies and consumers are hording their money instead of lending or spending it. This behavior leads to what Keynes described ask a "liquidity trap" in the economy. In the end, massive government expenditures, paid for with public debt, are needed to resolve the crisis.

Economists and politicians in many countries have now recognized -- and reacted to -- the fact that what the Financial Times calls the "mother of all financial crises" comes awfully close to the scenario Keynes outlined. Governments from Washington to Tokyo, hoping to slow down the economic decline, want to lower taxes, issue more government contracts and increase public assistance for businesses and the unemployed. The cloak of emergency aid has already been used to conceal a number of new subsidies, including assistance for the US banking industry and the ailing American automotive industry.

In Germany, on the other hand, the political elite has behaved as if it were dealing with a run-of-the-mill dent in growth. Members of parliament across the political spectrum have cautiously proposed a wide range of measures to jump-start the economy, while at the same time stressing that what they have in mind is not an economic stimulus program. Their proposals had hardly been unveiled before senior strategists at party headquarters began trimming away, arguing that government welfare for citizens should be saved for the election campaign.

As a result, the stimulus package Berlin's Grand Coalition government of Christian Democrats and Social Democrats plans to unveil this week will be greatly reduced in scope. It is expected to include a few tax incentives for car buyers, private households and businesses, as well as low-interest government loans for municipalities and homeowners. While the German government is providing close to €500 billion ($747 billion) to bail out the banks, it expects to spend no more than €5 billion ($7.5 billion) a year to boost the real economy. This is less than a quarter of the amount officials in Steinbrück's ministry have consistently named as the minimum necessary for an effective growth package.

After having hesitated for so long with its bank rescue package that countries like the United States and Great Britain ended up leading the way, the Grand Coalition is now about to propose a plan that would fall far short of expectations.

According to former Economics Minister Wolfgang Clement, a Social Democrat, what Germany needs now is "heavy investment in schools and universities and a compact infrastructure investment program." Clement believes that the only solution to the global economic crisis is a "global investment boom," and that this is not the time to get bogged down in details, but rather to take a more forceful approach.

But officials at government headquarters in Berlin have a different take on the economic situation. "A broad stimulus program," Chancellor Angela Merkel said last week, would only set off a "short-term blaze."

It is certainly true that economic stimulus programs can be harmful if they are poorly planned and put in place at the wrong time. But when applied in a sensible way, such programs have often proved to be beneficial.

"Right now, increased government spending is just what the doctor ordered," says this year's winner of the Nobel Prize in Economics, Paul Krugman. Dominique Strauss-Kahn, the director of the International Monetary Fund, seems to agree when he proposes "quick and forceful" multinational spending programs.

This advice is partly intended for Germany. As recently as late summer, the German economy was considered extremely crisis-proof, with its relatively manageable banking sector and many fundamentally solid exporting companies. The experts, hoping to preserve calm, said that this combination of factors would help Germany navigate the financial crisis more effectively than most other industrialized nations.

But now it is precisely this strength in world markets that has become so disastrous to the German economy. A Wall Street banker who has lost his job is unlikely to be buying a Porsche these days. And Russia's cash-strapped oligarchs now lack the capital to buy German building machines. With key buying countries like the United States and Great Britain rushing into recession, business is also suffering in Germany, the world's leading exporting nation.

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• Part 1: Economic Crisis Mounts in Germany
• Part 2: 'Any Plan I Make Is Obselete the next Day'
• Part 3: Can Efforts Stop Downward Spiral into Recession?