Germany’s economic resilience is crumbling, fueling fears of a recession and increasing pressure on the government to deliver a fiscal stimulus package.
Economic data released Wednesday revealed that the German economy shrank by 0.1% in the second quarter of 2019, having grown by 0.4% in the first quarter. Manufacturers and the construction sector bore the brunt of a global slowdown amplified domestically by trade conflicts and Brexit uncertainty.
The shrinkage in GDP (gross domestic product) growth marks the end of a decade of expansion for the German economy, which has grown by an average of 0.5% quarter-on-quarter every quarter since the end of the 2008/9 recession, expanding in 35 of the last 40 quarters.
However, since the third quarter of 2018, the economy has been in de facto stagnation, with quarterly GDP growth averaging 0%.
Resistance is crumbling
In a note on Wednesday, ING Chief German Economist Carsten Brzeski said that while the industry slowdown is not particularly new, recent developments indicate that “the resilience of the domestic economy to external shocks is crumbling.”
“Profit warnings, first lay-offs, an increase in short-time work schemes, falling consumer confidence and weaker activity in the service sector have sounded the alarm bells,” Brzeski said.
Trade conflicts, Brexit uncertainty and global geopolitical crises, along with an ailing automotive sector, have all taken their toll. The German economy ministry said in its monthly report on Wednesday that the outlook “remains subdued for the time being.”
“Trade conflicts have recently worsened and the prospects for an orderly Brexit have not improved,” the report added.
Brzeski suggested that the weakening of the domestic economy is the most worrisome trend facing Germany, rather than wider economic stagnation.
Barclays vice president of macro research, Iaroslav Shelepko, also said that Wednesday’s GDP print confirmed the vulnerability of the German economy to external demand slowdown, amid heightened uncertainty over trade.
German industrial output posted a quarterly decline of 1.9%, its steepest quarter-on-quarter fall since the last technical recession observed amid the euro area debt crisis in 2012/13. However, Shelepko suggested that domestic demand has thus far demonstrated “remarkable resilience” due to the services sector offsetting much of Germany’s trade-related industrial weakness.
“Looking into Q3, the labor market will be key to watch for any emerging cracks amid the ongoing industrial recession,” Shelepko said.
“Disposable income growth and private consumption resilience might be at risk should the downturn in the industrial sector spread into services.”
Combined with continued external challenges, such as persistent trade-related weakness in global demand and elevated geopolitical uncertainty, Barclays expects the German economy to post another mild decline in the third quarter of 2019, therefore entering a technical recession even before Brexit and the risks to U.S.-EU trade are due to crystallize.
Time for stimulus
Brzeski said Germany needs a “two-pillar stimulus package” comprising a short-term stimulus and an increase in the “long-run growth potential.”
This stimulus will have to go beyond state measures such as “bank bailouts, scrapping and short-time working” which were successful in 2008/9 because the economy was fundamentally sound, and must instead address structural problems.
“The buzzwords are well-known: digitization, climate protection, energy transition, infrastructure and education,” Brzeski added.
He highlighted growing support to agree on climate change measures in September, to increase investment in digitization, and to reduce the so-called solidarity tax as indicators of long-term reform.
The solidarity tax, a government-imposed tax levied in a bid to fund theoretically unifying projects, was introduced at a flat rate of 7.5% on all personal income after the reunion of East and West Germany in 1991.
Brzeski also suggested that there is ample fiscal room for maneuver.
“The government’s interest payments have dropped from 2.7% of GDP in 2008 to some 0.8% of GDP this year,” he said.
“The government could run fiscal deficits of some 1.5% of GDP and the debt-to-GDP ratio would still stabilize at 60%.”
While running deficits instead of surpluses is currently “still more than one bridge too far” for the German government, some fiscal loosening looks “more likely than many might think,” he concluded. Without this, the outlook for the German economy will be beholden to external factors.
Prince Harry and Meghan will no longer use ‘royal highness’ titles
Prince Harry, Duke of Sussex and Meghan, Duchess of Sussex gesture during their visit to Canada House in thanks for the warm Canadian hospitality and support they received during their recent stay in Canada, on January 7, 2020 in London, England. (Photo by DANIEL LEAL-OLIVAS – WPA Pool/Getty Images)
Prince Harry and Meghan, the Duke and Duchess of Sussex, will no longer use their royal titles or receive public funds for royal duties, and will repay millions of dollars in taxpayer money used for refurbishing their home in Windsor, the Buckingham Palace announced on Saturday.
The deal comes just 10 days after the couple announced they will step back as senior members of the Royal family and split their time between the United Kingdom and North America.
“As agreed in this new arrangement, they understand that they are required to step back from Royal duties, including official military appointments. They will no longer receive public funds for Royal duties,” the Buckingham Palace said in a statement.
“With The Queen’s blessing, the Sussexes will continue to maintain their private patronages and associations. While they can no longer formally represent The Queen, the Sussexes have made clear that everything they do will continue to uphold the values of Her Majesty.”
The couple intends to repay £2.4 million in taxpayer money for the refurbishment of Frogmore Cottage, which will remain their U.K. family home, the Palace said.
The agreement takes effect later in the spring.
“Following many months of conversations and more recent discussions, I am pleased that together we have found a constructive and supportive way forward for my grandson and his family,” Queen Elizabeth said in a statement.
“Harry, Meghan and Archie will always be much loved members of my family,” she said. “I recognise the challenges they have experienced as a result of intense scrutiny over the last two years and support their wish for a more independent life.”
Davos elites will be buzzing about corporate responsibility and its limits
Klaus Schwab, founder and Executive Chairman of the World Economic Forum (WEF), addresses a news conference ahead of the Davos annual meeting in Cologny near Geneva, Switzerland, January 14, 2020.
The world’s most influential executives will soon swarm the World Economic Forum in Davos, Switzerland, where they will embrace the idea that corporations no longer exist simply to funnel profits into the pockets of shareholders.
They will talk about how their companies have tackled societal issues — from diversity to climate change.
Powerful politicians, potentially including President Donald Trump, will also be at the five-day event, which begins Tuesday, laying out the way they have held companies accountable, all while populist rhetoric remains a heated topic during this year’s campaign for the White House.
In the often-snowy Swiss village, stakeholder capitalism — a movement that redefines a company’s purpose from serving only its shareholders to all stakeholders, including customers and communities — will be the dominant theme. It will be the first Davos meeting since the Business Roundtable, a group representing the CEOs of nearly 200 companies, embraced stakeholder capitalism as its new purpose in August.
But conversations with corporate advisors, investors and experts paint a more nuanced picture of how corporate America is taking on the issues. It is one in which Congress’ ability to force corporate change is dwarfed by state governments. And the biggest driver of change originates from where it always has — investors. As some investors have shifted their focus to the public good, so have companies. Yet there will be limits to change as long as the largest investors care most about making money.
“So far, at most companies, their words are bigger than their actions,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business. “The other wordy people, politicians in an election year, aren’t as big a force as socially activist stockholders are. Stockholders like endowments and pension funds, who are more interested in stakeholder effects than are stockholders who look solely for returns, are the ones the corporations cannot ignore.”
Setting the stage for Davos and corporate America over the past few years is a generation for which social and economic issues have become nearly unavoidable. Issues like climate change are more tangible, due to disasters like the wildfires in Australia. Homelessness is more apparent to young urbanites as the problem swells in cities like Seattle and San Francisco. Income inequality is rising as technology and globalization alter the employment landscape.
With that, public pension funds are asking more questions — like whether private equity contributed to the demise of Toys R Us. Shareholder advocacy groups like As You Sow are pushing for shareholder votes on issues including climate change and human rights.
The country’s biggest investors have joined in as well. Powerful names like ValueAct, Jana Partners and BlackRock have launched new funds that promote environmental, social and governance causes, known as ESG. The funds espouse the idea that investments that line up with public values are rewarded by the market place. Investing in alternative energy, for example, could be rewarded as countries move toward shifting their power standards.
David Orrell | CNBC
It was with that view that BlackRock CEO Larry Fink announced that the world’s largest money manager will exit investments with a high sustainability-related risk like coal. He attributed the move to “a fundamental reshaping of finance” and warned that climate change is a “defining factor in companies’ long-term prospects.” He also said the group will join the Climate Action 100+ investor coalition, which focuses on tackling greenhouse gas.
Limits and profits
But for funds like BlackRock, profit will always be the driving goal. To that end, there are reasons beyond the public good for ESG funds. As passive investing overtakes active, they offer a way to stand out to the Street. ESG funds may also endear the big investors who back them to proxy advisory agencies like the Institutional Shareholder Services when they agitate for seats on company boards.
It is with that caveat that some question how far funds like BlackRock and Vanguard are willing to go.
As an example, the Sierra Club’s Michael Brune applauded BlackRock’s announcement, while also noting that the firm voted against every single resolution backed by the Climate Action 100+ investor coalition.
And behind the scenes, large funds like BlackRock are less focused on some of the demands that could create the most drastic change — like tying pay to ESG performance — than they are on shareholder return.
“When companies have to talk to their shareholders about ESG issues, risk management and culture are among the top topics,” said Bill Anderson, global head of Evercore’s Activism Defense business and Strategic Shareholder Advisory practice. “Despite the heightened focus on stakeholders, most companies provide near-term guidance and compensation continues to focus on short-term total shareholder returns.”
Some executives argue that improved shareholder returns can help CEOs benefit society in other ways, like through charitable endeavors. But so long as CEOs’ pay is tied to Wall Street performance, there is room for examples of discord between what benefits wallets and the world.
Boeing’s former CEO Dennis Muilenburg, who was fired last month for his handling of the 737 Max crisis, walked away with more than $60 million, despite being denied severance. In 2018, the majority of his compensation was tied to performance-based bonuses linked to short-term incentives, like sales, cash-flow and earnings-per-share and longer-term metrics like its 3-year profit goal.
“Yeah, you killed 346 people,” Rep. Peter DeFazio, D-Ore. recently told reporters, arguing that a disproportionate focus on share price “somehow has got to change.”
Muilenburg was a board member of the Business Roundtable until he was ousted as Boeing CEO in December. At a press conference earlier that month, then-Business Roundtable Chairman Jamie Dimon, the CEO of J.P. Morgan, scoffed at the notion that there was a disconnect between the Business Roundtable’s stakeholder capitalism and Muilenburg’s board-seat.
The Business Roundtable is “not an enforcement group,” Dimon said. “[…] And yes, companies are going to make mistakes and have problems and that’ll never end — truthfully like any institution you’ll ever see on the planet — including the press.”
Disclosure as enforcement
Business Roundtable CEO Joshua Bolten said at the same press conference that “every single one of the CEOs who are members” of the group is already engaged in supporting their customers, employees and communities, as well as shareholders. Its new purpose is a challenge to its CEOs to “do better and more,” he said. From the Business Roundtable’s standpoint, that means engaging in policy debates like its push for a federal increase in the minimum wage.
But the minimum wage debate — like climate change, board diversity and privacy — is already being tackled by the states, far ahead of federal regulation.
While the federal minimum wage has held steady at $7.25 an hour since 2009, nearly half of states raised their minimums in 2019. In turn, companies are already responding, with everyone from Walmart to Amazon having already announced plans to raise their wages.
“I think every CEO of a large company knows that it would be difficult to have big changes at the federal level, because most corporate law is done at the state level,” said Michigan’s Gordon. “It costs nothing for a CEO to throw out a bill proposal. You can’t accuse them of doing anything other than what politicians try to do — you hold hearings — its Kabuki theater.”
A general view shows the congress centre, the venue of the World Economic Forum (WEF) in Davos, Switzerland January 13, 2020.
Arnd Wiegmann | Reuters
That’s not to say the federal government has no powers, whether it be through investigations or lawsuits.
One of the tools the federal government has at its disposal to impact ESG is still little used: disclosure requirements imposed by the Securities and Exchange Commission.
A Dodd-Frank rule requiring the SEC to adopt rules that force disclosure of CEO pay ratio brought the issue to the forefront in boardrooms, corporate advisors have told CNBC.
There is no uniform SEC disclosure standard for most ESG issues, so there is no clear way to hold companies accountable beyond press releases and hard to parse ESG reports.
Without a clear public measuring stick, companies can more easily slip through the cracks of accountability, say industry experts. For that reason, there are pushes to force the SEC to impose such standards, like Sen. Elizabeth Warren’s proposed Climate Risk Disclosure Act.
There are inherent challenges in creating such requirements. They would add more compliance costs as public companies are already arguing the costs of being public are too onerous. It is difficult to create a metric by which to measure issues like environmental impact that would work for an array of industries, from energy to services.
With that, the SEC is unlikely to impose such rules in the short term, industry experts say. The agency, led by Jay Clayton, a Trump appointee, has made simplifying corporate disclosures among its priorities.
Indeed in November, the SEC proposed a pair of rules that would raise the threshold for investors to call for a vote on specific issues, making it harder for them to press climate change and gender equity issues.
Among the groups that pushed for the SEC to raise that threshold was the Business Roundtable.
— CNBC’s Leslie Josephs and Amelia Lucas contributed to this report
World leaders in Davos confront critical historic moment
A century ago this month, the Treaty of Versailles went into effect, bringing World War I to an end. Yet the dreams that paved its way were already evaporating. Among them was U.S. President Woodrow Wilson’s vision of “a world made safe for democracy” and his hope that the League of Nations would emerge to prevent future conflict.
As world leaders gather in Davos next week at the dawn of the 2020s, they confront a similarly decisive historic moment and a comparable set of dashed hopes. One can hear the haunting echoes from the 1920s: a U.S. isolationist temptation, bitter European disunity, and growing nationalism and populism within democracies amid rising authoritarianism.
As with the end of World War I, the Cold War’s end in 1989 spawned premature declarations of democracy’s triumph. In his 1992 book The End of History and the Last Man, Francis Fukuyama suggested that with Soviet collapse humanity had reached “the end-point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.”
What world leaders coming to Davos know is that history’s course is up for grabs again. Major power competition is heating up, inflamed by a systemic contest between democratic and state capitalism. The world is awash with uncertainty about how new technologies and rising environmental threats could remake our world. The international order of rules and institutions that the U.S. and its partners constructed after World War II is faltering and ill-equipped to navigate these challenges.
In the World Economic Forum’s program notes, it writes: “There are 193 sovereign nations, a proliferation of regional centers of power, and one increasingly obvious fact of life – we’re all in this together… We need to move from geopolitics and international competition to a default of consummate global collaboration. Nations are going to have to change.”
But what if, far more likely, they don’t?
“Those who cannot remember the past are condemned to repeat it,” wrote the philosopher George Santayana in 1905. The silver lining of World War II’s devastation was that chastened American and European leaders, having witnessed the mistakes of Versailles, did a far better job than their predecessors in shaping the future. For example, Wilson’s young assistant secretary of the Navy, Franklin Roosevelt, had become President, and isolationist arguments drowned at Pearl Harbor.
The challenge facing today’s leaders in Davos is they must navigate the world to a better place without personal memories of failed settlements or the world spanning catastrophes that resulted, and can again, from lack of common cause.
It took a catastrophic war with millions of dead, followed by a half century of ideological competition between liberal democracy and communism, to prove Mussolini wrong. What will it take this time to answer Putin, and his ilk, following the constitutional change he proposed this week to ensure he can stay in power as long as he may want?
One can only hope that democracies regroup, finding a means of peaceful coexistence and competition with China, Russia and others. Can they agree to rules and remake institutions in a manner that doesn’t surrender fundamental values? Perhaps the best outcome would be an extended contest over time, decided in degrees and not through geopolitical catastrophe.
For those keeping score at this year’s Davos, here are just three questions, among many others, worth asking about this epochal drama.
What is the state of U.S-Chinese relations following this week’s trade agreement?
When President Trump speaks in Davos on Tuesday, even as his Senate impeachment trial begins, he’s likely to make much of his Phase One trade agreement signed this week.
However, despite this “ceasefire,” the two most decisive countries for the global future will continue to grow apart politically, economically and technologically. Though financial markets have been calmed, the more significant story is this decoupling.
A recent Atlantic Council delegation in China found that many Chinese experts and officials welcome the U.S. trade war and technology transfer restrictions as they are spurring China toward greater self-sufficiency.
“Beijing is accelerating its drive for technological ‘autonomy,'” Yuan Yang wrote in a sweeping Financial Times analysis yesterday, “to boost its control over its own supply chain in the face of political risks, such as further US embargoes.”
Can the U.S. and Europe avoid new trade wars – and find common ground regarding Iran?
The good news is that the United States, the European Union and Japan this week proposed new global trade rules for the World Trade Organization, clearly aimed at China, that would curb state subsidies that are distorting the world economy.
The bad news is that the Trump administration continues to consider escalating its trade conflict with Europe when instead it should be forging a new trade and investment agreement.
The transatlantic relationship has been at the core of one of the longest periods of relative peace and prosperity over the past seven decades. It’s time to refocus U.S. and European efforts at recharging those ties.
One good place to start might be Iran. One good outcome from rising U.S.-Iranian tensions could be that Iranians’ steps to break out of its nuclear agreement could trigger closer cooperation between Washington and its European partners to constrain those activities and seek new talks.
Could the Australian fires shock the global community into the sort of common cause that Davos promotes?
“Welcome to a world in which climate change’s economic impact is no longer distant and imperceptible,” writes Greg Ip of the Wall Street Journal. “Climate has muscled to the top of business worries.”
And Davos-regular Laurence Fink, the chairman and CEO of the world’s largest asset manager BlackRock Inc., said this week that climate issues would be a key driver in how he invests more than $7 trillion of his clients’ money.
Yet even as fires burn a patch of Australia the size of Belgium, it’s going to be politicians more than business leaders who have the biggest levers for change. For all the increasing climate rhetoric, emissions continue to increase, and heat rises.
A century ago, the failure of global leaders to foresee and head off future risks ended in the flames of WWII and the Holocaust. Once again, the cost of failure will be paid on a global scale.
Frederick Kempe is a best-selling author, prize-winning journalist and president & CEO of the Atlantic Council, one of the United States’ most influential think tanks on global affairs. He worked at The Wall Street Journal for more than 25 years as a foreign correspondent, assistant managing editor and as the longest-serving editor of the paper’s European edition. His latest book – “Berlin 1961: Kennedy, Khrushchev, and the Most Dangerous Place on Earth” – was a New York Times best-seller and has been published in more than a dozen languages. Follow him on Twitter @FredKempe and subscribe here to Inflection Points, his look each Saturday at the past week’s top stories and trends.
For more insight from CNBC contributors, follow @CNBCopinion on Twitter.
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