Quick Hit: German GDP

With Afghanistan and Delta still hogging most headlines in the UK Tuesday, there was little new for investors to mull over. Enter Germany, which reported the details of its Q2 2021 gross domestic product (GDP, a government-produced measure of economic output). In our view, a quick look at how GDP’s various components fared can help investors put the widespread reports of global supply shortages and shipping delays in a helpful context.

Many commenters we follow portray Germany’s economy as uniquely vulnerable to the shortages of various raw materials and components, tied to its reputation as Europe’s industrial powerhouse. The country’s reputation as a large exporter also makes it vulnerable to the widely reported delays at various ports, not to mention the shortage in shipping containers and high sea freight rates. That is the backdrop for Q2’s report, which gave investors their first clear look at how these issues are affecting Germany’s economic recovery from COVID thus far.

Overall, we think the results do show some impact, but not large enough to derail the recovery—at least not yet. GDP grew 1.6% q/q, slightly faster than the initial estimate of 1.5% q/q.^[i] Consumer spending led the charge with a 3.4% q/q rise, confirming the Federal Statistics Office’s earlier observations that services did the heavy lifting whilst global supply chain chaos hampered manufacturers.^[ii] Yet in heavy industry, it wasn’t all bad news. Business investment in capital equipment eked out 0.3% q/q growth, and exports rose half a percent.^[iii] Imports, which statisticians subtract from GDP to focus the gauge on single-country output but, in our view, represent domestic demand—as well as shipping activity—rose 2.1%.^[iv] So, following the pattern in other developed nations—including the UK—supply shortages and shipping delays remained a surmountable obstacle in the quarter.

The lone category to contract was collective government consumption, which refers to spending in broad areas like defence and public safety (versus spending on individual services, including education, housing and health care). Total government spending still grew, but the -1.5% q/q drop in collective spending dragged down the federal government’s broader contribution.^[v] That might not ordinarily be major news, but collective government consumption is the category where Germany’s big COVID relief spending showed up in GDP in Q1 and Q2 2020. It fell in Q3 2020 as the economy reopened and private businesses resumed driving economic activity, but as new restrictions emerged and lingered in late 2020 and early 2021, the government amped up its response again. Now, with the country reopening once more, it appears officials are once again stepping back.

Whilst, in our opinion, Germany’s recovery doesn’t depend on public spending, as the private sector is the country’s primary economic engine, this is emerging as a central issue in the ongoing campaign for 26 September’s Federal election, as our commentary last week discussed. Germany has a constitutional deficit cap, which normally limits the degree it can run a deficit to spend big. The government suspended it temporarily to deal with the pandemic, but now the ruling Christian Democratic Union (CDU) party wants to reinstate it and get back to the pre-pandemic norm. Tuesday’s news that Germany’s public deficit soared to €80 billion—or 4.7% of GDP—in the year’s first half, which is the biggest shortfall since 1995, heightened calls for fiscal discipline in some quarters.^[vi] But the Social Democratic and Green Parties—not to mention a large segment global financial commentators—have called for more spending, arguing Germany needs big fiscal stimulus. Not just to steer the economy through the global supply disruptions, but to shake off the slow growth that marked the 2010s. Some argue German stimulus is crucial globally, lest domestic demand sag and Germany leech money out of the rest of the world with giant trade surpluses.

As discussed last week, we don’t think the election’s precise outcome is possible to predict—rather, we highlight the debate to help investors put the various claims in context. As the GDP report illustrates, Germany’s economy is growing enough to offset government’s reduced contribution—a point we have observed most commentators overlooking. In our view, it is key to understand this is a political debate whose economic implications are likely much smaller than politicians imply.

We think the main lesson from Germany’s Q2 GDP report is that its economy is resilient. The results show the services sector (which generated 62.6% of German GDP before the pandemic) is big and strong enough to compensate for supply-related weaknesses in the industrial sector.^[vii] Additionally, the broader economy was able to rebound from Q1’s contraction even as the government pulled some support. That economic strength, in our view, is what equity markets have been pricing in—and as it seemingly remains underappreciated. Bull markets, long periods of overall rising equities, are often said to climb a wall of worry. The backdrop in Germany suggests there are plenty of bricks remaining today.