During the Euro crisis, now almost a decade away, the notion of a Euro Area economy lost its hegemonic appeal and was again seen as nothing more than a simple sum of its parts. Only with ECB president Mario Draghi’s “Whatever it takes” speech on a summer day in London 2012 was the disintegration process halted, or at least slowed.
No matter how we feel about that process or what we believe will happen over the medium and long term, the European economies are inextricably linked, and a very simplistic way of showing how economic integration has developed is with an expanding PCA 1. If cyclical developments are becoming more similar, the relative eigenvalues of the first principal components should be increasing (at least on trend).
I cannot think of a vivid way to make the words of Jean Monnet, one of the founding fathers of European cooperation, come alive: “Europe will be forged in crises, and will be the sum of the solutions adopted for those crises.”. The relative Eigenvalues (weights) – the cumulative proportion – of the first principal component of the constituting Euro Area economies has risen from around 50% before the crisis to around 70% after the crisis. Put another way, the “European business cycle” today explains around 70% of each country’s individual business cycle (for simplicity I have used GDP-growth in % y/y). As can also be seen, the Euro crisis can be considered somewhat of a level shift in that regard.
That does not necessarily mean that individual countries can exert strong influence on the whole of the Euro Area and due to its size, among other things, the German economy is still leading the European economy. And the surprisingly weak developments during H1 2019 have been a preoccupation for policy makers and financial markets alike.
 Of course, this does not take into account to what degree this is a post-GFC, global phenomenon.
While forecasters gradually upgraded their forecasts in 2017, both 2018 and 2019 have only known downgrades. Considering that fiscal policy has actually been loosened from 2017 to 2018 and from 2018 to 2019, expectations have been high for the German consumer to supplement the German export machine in keeping up growth.
And, on trend, the Swabian hausfrau has done her best. Retail sales growth has outpaced most other sectors, but further loosening of (an admittedly contractionary) fiscal stance is probably necessary to push domestic growth higher, especially as earnings growth is not showing any clear signs of picking up.
The reason being, of course, the pervasive impact of a German export machine that is sputtering considerably. And despite Turkey being initially purported as a main explanation for the weakening performance, it can be seen that events in other, larger trade partners have soured considerably from a German perspective.
So what does the future hold? – Well, as long as fiscal policy is not being loosened more considerably, the German economy will be at the whim of global economic developments. Despite posting a tight labor market, hoping for accelerating wages seems far off, as unions and employers are paying a lot of attention to international demand for German products that seem to be petering out.
And forward-looking indicators are not a happy read either.
Overall business sentiment (red) is already among the lowest in Europe. The industry considers its situation even worse than its Italian counterpart. The only thing lifting the mood of the German business sector right now is the stellar performance of the construction sector. However, given our previous discussions, it is fair to ask how long that can possibly last.
My money is on the steady-as-she-goes behavior of the Swabian Housewife, visible in the stable and positive views from the retail sector. But she could very well do with a bit of help from German politicians focusing on improving the functioning of the German economy; infrastructure, schools etc. – There are plenty of sound ways to stimulate. Alas, they still seem unable to act. And if they are unable to do the right thing now that the fiscal house is in order, then when?