The pillars of Germany's economy are crumbling. Three reasons for worry

<p>I'm struggling to see a way forward for the German economy.</p><p>Today's data <a href="https://www.forexlive.com/news/germany-june-industrial-production-15-vs-05-mm-expected-20230807/" target="_blank" rel="follow">showed </a>German industrial production falling 1.5% in June. That was worse than the 0.5% decline expected and continues a series of soft readings for factories. </p><p>Production is now down 1.8% year-over-year and that may just be the start. German electricity use has fallen more than almost anyone thought possible. Some of that comes down to conservation but a great deal is due to the closure — likely permanently — of energy intensive industry.</p><p>The country is already in a recession and there's no clear way out. Instead, there are mounting headwinds both internally an externally. Here are three reasons why markets are worried:</p><p>1) Autos</p><p>Automotive manufacturing and exports are at the heart of the German economy. Their machines have powered Europe and been a worthy competitor to the US and Japan. But there is a new rival: China. The burgeoning automotive manufacturing sector in China is coming for everyone but Germany's export-sensitive model may be most at risk from China's EVs. At best, it's a formidable wave of competition that hurts margins and weakens Germany. At worst, it hollows Germany's key high-wage industry.</p><p>2) Energy</p><p>Germany's economic model is exporting manufactured goods, with China as a target market. Competition from China is already a major obstacle but it's compounded by rising energy costs. Germany survived the winter of 2023 better than I expected but that was with heavy subsidies and good weather. That's not a formula for the long term and aside from pie-in-the-sky hydrogen talk, I don't see a way for Germany to get away from expensive imported LNG.</p><p>3) Deficits</p><p>Last week German economy minister Robert Habeck offered up a harsh truth. He said Germany faces five difficult years of deindustrialization from high energy prices. He called for more subsidies for energy as a bridge to around 2030 when he estimates that green energy will take over. </p><p>The problem for that is budgetary. Eurozone countries are bound to deficits of less than 3%. Germany is currently running at 4.25%, up from 2.6% a year ago. Finance ministry estimates see the deficit falling to 0.75% in 2026 but that assumes that all energy subsidies are ended. Therein lies the rub: Either they cut the subsidies and lose industry or subsidize and break deficit rules.</p><p>For years, Germany was the policeman of the deficit system and periphery countries may wish to give it back some of its own medicine and the German public is also famously austere. The problem is that even if high subsidies stay in place, German industry is under heavy pressure. If anything, the subsidies need to be stepped up.</p><p>What will happen?</p><p>German politics are tough to predict, particularly in the post-Merkel era. The decision to shut down nuclear power looks disastrous in hindsight and a decisive moment in modern Germany economic history. Demographics are a headwind and the model of importing raw materials from Russia and fabricating it into high-value goods is dead. </p><p>There is a window for large subsidies but the government must decide if that fiscal ammunition should be spent on subsidizing industry, the green transition or some combination of both. Ideally, the taps would be fully opened but I fear that old instincts around spending will win out, dooming Germany's economy.</p>

This article was written by Adam Button at www.forexlive.com.