The Calm Before the Storm Bracing for the Global Downturn

As the year draws to a close, and as the world faces recession, a credit crunch and job worries, the economic outlook is the bleakest it has been in postwar history. The next year is expected be a test of strength for the German economy. Will the country's export strength prove to be its Achilles heel?

Last Friday, the world came to a standstill in Sindelfingen, a town located near Stuttgart. On normal days, about 1,500 trucks and 52 rail cars arrive at the Mercedes plant in Sindelfingen, carrying steel and glass, tires and dashboards, headlights and seats. More than 36,000 employees pass through the factory gates every day to develop new models and assemble the current ones -- the Mercedes C, E and S classes. On normal days, at least 1,500 cars roll off the assembly lines at the plant. But what is normal nowadays, with new reports on the recession coming in each day?

Now the Mercedes plant is closed -- until Jan. 11. Production facilities worth billions have been shut down. Everything, from the paint shop to the welding and production robots to the assembly line itself, has stopped moving.

Daimler, like Ford (at its German plants), Opel, BMW and VW, has stopped production temporarily. The German auto industry, which is responsible for one in seven jobs, is putting itself into something resembling an artificial coma. Some companies are using working time accounts to keep their employees at home, while others have introduced a shortened workweek. No one knows what will happen next year.

When plants are shut down in Germany's automotive production centers -- Stuttgart, Munich and Wolfsburg -- it also affects the employees of the carmakers' suppliers: engineers working for transmission manufacturers, technicians with the steel companies, and creative talent at ad agencies. Silence has descended on places that were once hubs of busy activity, from hammering to filing, drafting to designing.

And a ghostly silence it is, this national standstill. Order volume has plummeted across the board in German industry, and the markets are shrinking at a breathtaking pace. Planned investments are being cancelled or postponed. The economy has entered a recession of previously unimaginable proportions.

The Greatest Stress Test Since Reunification

Economists are predicting new alarming scenarios for 2009 almost every day. Pessimistic estimates of the amount by which the German economy will shrink range from 0.8 to 2.2 percent.

Experts are also outdoing each other with worrisome new unemployment figures. The Organization for Economic Co-operation and Development (OECD) remains cautious and expects about 700,000 people to join the jobless in Germany by the end of 2010. Others, like Dirk Schumacher, chief economist at the Goldman Sachs office in Germany, want to prepare us for the worst: Six million jobless, he says, is conceivable.

Even the German government is revising its forecasts. While the experts in Berlin predicted miniscule growth for 2009 in October, they now expect the economy to shrink by 2 percent. This would catapult the government deficit from zero to about three percent of GDP, to reflect decreased tax revenues and increased expenditures for unemployment benefits.

"On the whole, next year Germany will likely face its greatest stress test, at least since reunification," states the draft version of the government's new annual economic report, which also notes that economic development has "weakened drastically." The government's economic experts do not expect the economy to return to positive territory by 2010. And on Wednesday, the daily Süddeutsche Zeitung reported that, in its internal calculations, the government is expecting to generate at least €30 billion in new debt in 2009 -- three times as much as in 2008 and the highest level since 1996.

Despite the crisis, the coalition government in Berlin has not shown much leadership strength. Officially, Chancellor Angela Merkel of the conservative Christian Democrats continues to oppose additional large-scale government bailout programs. Merkel's finance minister, Peer Steinbrück of the center-left Social Democrats, seems to prefer quarreling with the British and French who, he insists, are frittering away their money with their bailout packages. In doing so, he has also angered many.

In the opinion of German Economics Minister Michael Glos -- a member of the Christian Social Union (CSU), the Christian Democrats' Bavarian sister party -- things are not moving quickly enough. Glos has been increasingly forceful in opposing his own chancellor and, by doing so, throwing his lot in with his party's new chairman, Horst Seehofer. As Bavaria's new governor, Seehofer is trying to demonstrate his strength in the run-up to next September's federal election. Party politics, it seems, has distorted much of the government's response to the crisis.

In November, the chancellor warned the public to be prepared for "a year of bad news." Never in the 60-year history of the Federal Republic of Germany have citizens been this anxious as they enter a new year, plagued by worries of how much worse things can get and, most of all, how safe their jobs are.

How Bad Will Things Get?

On the surface, there has been surprisingly little change. The Christmas markets are as crowded as ever, and traffic remains heavy on highways headed for ski regions. At €0.98 per liter of diesel ($4.92 a gallon), even filling up isn't quite as depressing as it was in the past. Could it be that things aren't nearly as bad as we have been led to believe? Crisis? What crisis?

But with each new report of companies having to increase their write-offs and of credit lines being terminated, there is a growing sense that the country is merely experiencing the calm before a powerful storm, and that it is approaching a turning point. The question is: How bad will it get?

Will 2009 be more like 2001, the year of the Sept. 11 terrorist attacks on New York and Washington, which was followed by only a brief downturn? Or like 1973, the year of the oil crisis, which marked the beginning of a decade of stagnation and inflation? Or will the future resemble 1929, the year the stock market crashed, leading to a worldwide depression that did not, in effect, end until 16 years later, with the end of World War II?

Exports, the Germany Economy's Achilles Heel

In Eisenhüttenstadt, a traditional industrial city near the Polish border, residents are preparing for the worst. ArcelorMittal, the world's biggest steel producer, has reduced the hours of 1,600 of its 2,700 employees at its Eisenhüttenstadt plant and plans to eliminate 300 positions altogether.

"When we cough, Eisenhüttenstadt gets pneumonia," says Jürgen Schmidt, an engineer. If he is right, the city must be very sick indeed.

Schmidt has been working here for the last 15 years, and things have gone uphill for most of that time -- until two months ago, when everything suddenly changed. "It was like someone applying the emergency brakes on a fast train," he says.

ArcelorMittal's customers, especially carmakers, have cancelled orders en masse. They have even stopped taking delivery on finished products. Demand has declined by one-third. After a repair in late November, one of the company's blast furnaces was simply kept shut down. "Maybe it'll start up again in the spring," Schmidt says optimistically.

But the news from around the world paints a grimmer picture. One country after the next is officially reporting the beginning of its recession, the value of all securities on the world's markets has virtually been cut in half, to about $26 trillion (€20 trillion), and companies are planning massive layoffs: 5,000 jobs at Dow Chemical, 5,300 at Credit Suisse, 12,000 at AT&T, 14,000 at the mining conglomerate Rio Tinto, 16,000 at Sony and up to 35,000 at Bank of America. Citigroup has plans to eliminate 53,000 jobs.

What is most astonishing is the incredible speed with which the crisis is spreading from one company to the next.

Shrinking demand for cars affects more than just automakers like Daimler or VW. The suppliers of plastic parts suffer, as well. They, in turn, order less granulated plastic from chemical companies, which in turn reduce their production of naphtha, a product made by distilling petroleum.

In this way, the deterioration in the automobile market ultimately affects oil companies like Exxon, Shell and BP, not to mention the countless skilled tradesmen, couriers and caterers who work for all of these companies and also suffer from the decrease in orders.

Few industries have been spared. The crisis affected the car and truck industry first, because consumers can easily rationalize postponing a new car purchase, knowing that their existing cars are usually sufficient. The chemical industry, as a key supplier to the auto and construction sector, is next. Dow Chemical, for example, has already cut back production at its plant in Stade outside Hamburg by half.

Machine building, Germany's most important industry, will not be spared either -- although the crisis will hit it with some delay. Companies in the sector still have a backlog of orders to process, which could keep them busy for months or even years.

The effects of the recession are the most severe in those businesses that have already seen better days, including video rental stores, clothing retailers, department stores and the semiconductor industry. In these businesses, every crisis accelerates structural change, no matter how much the government -- as in the case of chip producer Qimonda -- attempts to offset the decline.

The core issue in Germany revolves around the future of a domestic economy that depends more heavily than most on the global economy. Does this make Germany especially vulnerable?

"Exports are the Achilles heel of the German economy," says Berlin economist Henrik Enderlein. Will its strength in foreign trade end up being Germany's downfall? Or will the unique profile of German industry enable it to escape the crisis largely unscathed?

Feeling the Pinch

No other country in the world has profited as much from the worldwide interconnectedness of markets since the fall of the Berlin Wall. In the last 15 years alone, the percentage of the total economy devoted to exports has grown considerably, from 24 to 47 percent. This could make the impending plunge all the more precipitous.

The ports are a case in point. In Hamburg, for example, the booms of many cranes are left idle, with many container ships arriving at the port's terminals only half-full. In the northern German port of Bremerhaven, the country's most important transshipment point for cars, business is stagnant. Parking lots at the port are crowded with 90,000 new cars, one-third more than usual.

The World Bank expects global trade to shrink in 2009 for the first time in a quarter century. German companies are already feeling the pinch, now that the volume of orders from abroad has declined by almost one-fourth compared with November 2007.

France, the Netherlands and Great Britain, Germany's main markets, are equally beleaguered. Meanwhile, demand is also declining across the euro zone, the 15 countries that have adopted Europe's common currency, which is the destination for two-thirds of German exports.

According to the draft of the government's annual economic report, the downward slide among key trading partners as Europe slides into a recession poses "a unique challenge," as Germany finds itself confronted with "a crisis in international demand." Consumption has also declined in overseas markets.

The Americans, deeply in debt, can no longer afford products made in Germany. All hopes had been pinned on the so-called BRIC nations (Brazil, Russia, India, China), but they too are facing difficulties. In India, the terrorist bloodbath in Mumbai has made investors nervous. China is planning a $600 billion (€460 billion) bailout program to counteract the downturn there, and Chinese airlines are rethinking billions in orders for Airbus products. In Russia, the ruble is rapidly losing its value, causing the country's currency reserves to melt away.

The synchronicity of these events is what gives the crisis its unprecedented broadness and depth. Things could get even worse for the German export industry if the mountain of American debt causes the dollar to lose a significant amount of value. When that happens, German companies will find themselves with far fewer customers for their expensive products.

One of the greatest risks is that countries, following a typical pattern in times of crisis, will tend to seal off their markets. Russia, hoping to protect its domestic industry, plans to increase duties on imported cars. "My greatest fear is that we will see a wave of protectionism," says Berlin economist Michael Burda.

This would pose a considerable problem for the German auto industry. In addition to exporting a large share of the vehicles assembled domestically, German carmakers now produce almost one in two cars in factories abroad.

Auto Sales Take a Hit

Normally, this puts German manufacturers in a much stronger position than their French or Italian competitors, which are focused far more heavily on a single market, Europe. In a crisis, Mercedes, BMW and VW are normally able to effectively offset fluctuations in demand. But plummeting sales around the globe will also affect the Germans.

At an employee meeting last Tuesday Bernd Osterloh, the head of VW's works council, pointed out the potentially devastating effects on the company. Experts, Osterloh reported -- to a sea of glum faces -- have already lowered their original predictions for worldwide auto sales in 2009 from 62 million to 49 million vehicles.

The greatest risk to German manufacturers is that their business model is based solely on growth. In addition to having increased capacity by building new factories, they have raised productivity in existing plants by five to 10 percent each year. If sales do not grow at the same rate, or even decline, the carmakers will be forced to lay off employees.

Opel faces difficulties as a result of the existential crisis at its parent, General Motors. BMW has already slashed more than 8,000 jobs, and jobs could soon be in jeopardy within the VW Group. If the crisis continues, the Wolfsburg-based company will likely terminate some of its 18,000 temporary workers and its 25,000 contract workers.

Martin Winterkorn, the chief executive of Volkswagen, expects auto industry sales to take a hit in 2009. In a meeting with senior executives, he said that the company should prepare for a 20 to 25 percent drop in car sales worldwide. Although VW would not be as strongly affected, Winterkorn said, it too could expect to see sales decline by 10 to 12 percent.

Winterkorn knows exactly how difficult it is to sell a car these days. Whenever VfL Wolfsburg, the local Bundesliga football team, has a home match Winterkorn invites 10 VW dealers from the visiting team's city and asks them for their blunt accounts of how business is going for them. On Dec. 7, when a club from Hanover was the visiting team, the mood was dismal. "Nothing is moving," the dealers told Winterkorn. There are days, they said, when "not a single customer shows up in the showroom, and when the phone doesn't ring at all."

Many car dealers, even BMW and Mercedes-Benz dealers, are about to go out of business. Daimler has already paid its dealers more than €53 million ($70 million) to make up for their losses. In the long run, however, carmakers will be just as unable to keep cash-strapped dealers afloat as their ailing suppliers, which are finding access to capital increasingly difficult. Banks have either stopped lending altogether or are lending under less attractive terms. Even the automotive banks within the industry, used for decades as a means of stimulating sales, are in trouble.

The current economic crisis, which has its roots in the subprime mortgage crisis in the United States, is now eating its way through the entire German economy, and yet it has been only 13 weeks since the collapse of the investment bank Lehman Brothers.

An Economic Tsunami

No one could have imagined that this event would shake the global economic system to its core, that mortgage loans bundled into securities would trigger such an economic tsunami, and that the waves could reach as far as the average citizen's savings accounts in the most provincial parts of Germany. "The globalization of the financial industry reaches much further than many had believed," says economist Burda.

All confidence within the financial industry has been lost and has yet to be restored. The banks are hording their money. Within the euro zone, for example, banks have roughly €130 billion ($173 billion) on deposit with the European Central Bank, compared with less than €100 million in early September.

The banks are still afraid of lending money to each other, and even more hesitant to lend to their customers. It has even become difficult for financially sound companies to secure fresh capital. As a result, they are borrowing less and cutting back their investments, only adding to the adverse interaction between the financial crisis and the economic downturn.

TMD Friction, a manufacturer of brake friction parts in the western city of Leverkusen, has seen massive declines in orders from carmakers like Mercedes, Porsche, BMW and VW. In an era of just-in-time production, this means that manufacturing is brought to a standstill virtually overnight. The situation escalated last week, when the banks refused to bridge the liquidity gap, and the auto industry supplier filed for bankruptcy -- even though its operating business remained healthy, as CEO Derek Whitworth points out.

The future of many companies remains difficult to gauge. Only those with a healthy cushion of equity capital stand a good chance of surviving the crisis relatively well. Conversely, companies that have relied entirely on debt capital and have developed no reserves could find themselves quickly deflating. Companies that have already been bled dry by outside financial investors will be in similarly difficult straits.

A Wave of Insolvencies

Over the course of the year, well-known German companies like retailer Hertie, watchmaker Junghans and fashion house Wehmeyer have become insolvent, and another wave of bankruptcies could follow in 2009. Experts with Creditreform, a credit management company, already expect the number of bankruptcies to increase by more than 15 percent.

Some small and mid-sized companies have fallen for a special form of financing known as mezzanine financing, a hybrid form of equity and debt capital brokered by banks. Business was booming until recently. Between 2004 and 2007, banks provided 685 companies with about €4.1 billion ($5.5 billion) in fresh capital. The market was structured in exactly the same way as the market for toxic US mortgage loans, with banks packaging and securitizing their mezzanine tranches and selling them to investors -- but without conducting detailed audits and while keeping the transactions off their own balance sheets.

No one wants anything to do with mezzanine financing today. "The standard mezzanine market is dead," says Michael Nelles, a financial consultant in the western city of Essen. Nelles, together with investment bank Lehman Brothers, developed a mezzanine product for companies with modest credit ratings. His original plan was to raise €350 million ($465 million) for 108 companies, including German companies like Schneekoppe, a producer of breakfast cereals, but insurance companies and pension funds were uninterested in the project -- and then came the Lehman bankruptcy. Many of Nelles's small-business clients now lack the funding the project was meant to provide.

"Some will fall by the wayside," says Nelles. Hoping to avert disaster, companies are now selling their futures by mortgaging their assets to leasing companies, and sometimes even their brand names.


Fear has taken hold within many businesses, as employees wonder who will be eliminated next: steelworkers, bank employees, newspaper editors? Everyone is vulnerable. Outplacement consultants, who help laid-off workers search for new jobs, have already noticed sharp growth in new orders.

When laying off staff, companies generally proceed in several stages. First they take the soft approach, by not filling positions that have been vacated, allowing annual contracts to expire and imposing hiring freezes. If this is insufficient, their next step is to let contract workers go or shorten the workweek. The last stage consists of layoffs within the core workforce. The federal government is left with little time to take measures to offset the downturn.

The draft version of the annual economic report summarizes the government's current approach this way: "Global weak development in overseas demand must be offset domestically to avoid negative effects on the labor market." In other words, the government will have to throw its full weight behind billions in bailout programs to prevent new mass unemployment.

Searching for the Right Stimulus

The government now has the means to do so, thanks to disciplined spending habits and coffers still brimming from past tax revenues. Various instruments are being considered.

Stimulus payments, for example, have already been used effectively several times in the United States. However, Americans are famous for their love of consumption, while Germans are known for their fondness for saving money. For this reason, a stimulus program runs the risk of failing in Germany.

Besides, people could easily use their checks for products not made in Germany, such Chinese-made DVD players or Swiss watches. Finally, issuing stimulus payments requires bureaucratic expense, because not all citizens are centrally documented.

Lowering the value-added tax seems to be a simpler approach, but only at first glance. This measure, which Great Britain has just implemented in a great hurry, has its potential downside. Who will guarantee that retailers will in fact pass on the savings to their customers?

A reduction in the income tax, on the other hand, is attractive for several reasons. It reduces the burden on taxpayers, which could help the economy. And it provides partnerships, which are also subject to the income tax, with an incentive for investments.

But cutting taxes also has a significant drawback: Half of all German households pay no wage or income tax whatsoever. These are primarily low-income households, an important group in an economic stimulus program, because they are more likely to spend their tax savings immediately.

Reducing health insurance premiums would be a way to reduce the financial burden for most Germans. Almost everyone pays health insurance premiums, including blue-collar and white-collar workers, retirees and civil servants. To implement such a program, the government would have to increase its tax subsidies to the health insurance agencies, financing the increased expenditure with debt, if necessary.

This would bring down premiums, thereby increasing citizens' purchasing power. The catch? Monthly savings for consumers would be relatively small, raising doubts as to whether the measure could truly trigger a surge in consumption.

In the end, the government will likely employ a mixture of instruments. Chancellor Merkel currently seems to favor reducing the income tax, combined with a stimulus payment, in the form of a check, to those who pay no income tax. She also wants to expand government investment in transportation, schools and universities, programs that work directly by creating work and, as a result, income.

The package will be assembled and approved in the first quarter of 2009. "The federal government will carefully monitor economic development," the annual economic report promises. "In the event of an intensification of the international crisis, it will take advantage of its latitude to take additional stabilizing measures to relieve the burden."

In the end, however, the government cannot set everything straight. In fact, it is probably far less capable of doing so than politicians believe. Companies, for the most part, must overcome the crisis themselves.

For now, it will hardly be possible to avert the loss of many thousands of jobs with carmakers, in the chemical industry and in construction. On the whole, however, Germany stands a better chance than most countries to eventually regain its footing. German companies are world market leaders in many industries, and they will be the first to benefit from a regional upturn.

Hardly any corporate executive doubts that China and India will be important growth markets again after the crisis ends. In anticipation of the future upswing in these countries, Andreas Renschler, head of the Daimler truck division, has instructed his senior executives to push forward with plans to build a plant in India. "You will continue to march forward, just as planned," he told executives at a management meeting, pointing out that there will be life after the crisis. And when that happens, Renschler wants to make sure that the world's largest truck manufacturer will be among the winners.

For now, however, recession is in the cards. Daimler, like many other companies, has no choice but to impose a forced hiatus. Steelmaker ThyssenKrupp, for example, added two weeks to the traditional Christmas vacation at its plant in the western city of Krefeld, where it produces stainless steel.

Before that, the company shipped a 360-kilogram (790-lb.) star to the city where the crisis began: New York. It now graces the top of the Christmas tree at Rockefeller Plaza.


Translated from the German by Christopher Sultan.
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