'WORST DEPRESSION' SINCE 1930S

Optimism Dips As Economic Downward Spiral Continues

04/23/2009 04:47 PM

The German economy is sinking precipitously as a result of the global economic crisis, creating the worst downturn since the Great Depression. Politicians and labor leaders are concerned about social unrest, but the government remains firm in its conviction that its not time yet for a third stimulus package.

It's been a bad week for German Chancellor Angela Merkel. At the start of the week, she tried to cheer up her compatriots, saying the economy showed signs it may be bottoming out. Since then, though, it's been one negative economic development after the next.

The German economy is in a nose dive and is already in its worst slump in almost 80 years. Indeed Hans-Werner Sinn, the head of the respected Munich-based Ifo Institute economic think tank, is describing the current crisis as the "worst depression" since the global economic downturn of the 1930s.

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Germany's leading economic institutes are predicting a gloomy 2009, with GDP shrinking by 6 percent.

On Thursday, Germany's leading economic think tanks concurred in a report that the economy would likely shrink in 2009 by 6 percent of gross domestic product. The International Monetary Fund is estimating a downturn of 5.6 percent. Officially the government in Berlin has forecast a decline of 2.5 percent, but next Wednesday it is expected to revise that figure downward.

However Sinn also praised the German government for its work in combatting the crisis so far, describing it to the Frankfurter Rundschau newspaper as a "major stabilizing factor." He said with its first two economic stimulus packages, the German government had created hundreds of millions of euros in demand in global markets. "The blow came from the USA," he said, "and Germany served as a shock absorber." It has been a stimulus program for the entire world, he said, noting the strong number of imports coming into a country traditionally known for its exports.

Is Social Unrest at the Door?

With the situation looking dire, on Thursday the center-left Social Democrats' candidate for the largely symbolic office of German president, Gesine Schwan, warned that social unrest, some of which has already been seen in other parts of Europe, could soon be lurking around the corner in Germany. "I can imagine that in two to three months the people's anger could increase markedly," Schwan told the Münchener Merkur newspaper. If people have no hope for an improved situation, she warned, it could get explosive. Michael Sommer, the head of DGB, one of the country's leading labor unions, also warned of unrest.

With no end in sight for the crisis, it's getting increasingly difficult for the German government to buoy spirits.

On Wednesday, Merkel called together 30 top politicians, executives, union leaders and industry officials to discuss the dramatic developments. Little of the optimism Merkel expressed at the beginning of the week remained and she was reserved in her comments. Merkel spoke of a "serious economic collapse," and Finance Minister Peer Steinbrück described an undamped downward dynamic. For his part, German Economics Minister Karl-Theodor zu Guttenberg prophesized a "very, very difficult year." The politician -- who belongs to Bavaria's conservative Christian Social Union, which is part of the government as the sister party to Merkel's Christian Democrats -- said that when he revises the government's forecast next week, it will be "considerably worse" than it was in January. Back then, the Economics Ministry predicted a drop in gross domestic product of 2.25 percent.

Against that backdrop, German unions are demanding a third economic stimulus package. It's a move the federal government has so far refused, saying it wants to let the first measures, with a volume of €80 billion, take effect first. Finance Minister Peer Steinbrück described union demands for an additional €100 billion spending package as "counterproductive."

Trade unions are critical of the government's wait-and-see attitude. "We need policies that tackle the problem head on and extensive job guarantees for employers," DGB union chief Michael Sommer told the weekly newspaper Die Zeit. In light of the depth of the crisis, he said, the government needed to improve its stimulus efforts.

Wolfgang Franz, the head of the panel of prominent economists who advise the German government, told the Mannheimer Morgen newspaper that the first two stimulus packages, particularly the second, must be allowed to gain traction. He added that the crisis-precipitated drop in energy and food prices, with a volume of around €30 billion a year, could have an impact similar to a third economic stimulus package.

Economists Call for Stimulus Discretion

Germany's top economists say the federal deficit is growing precipitously and that new stimulus programs should be rejected unless all the efforts up until now to spur the euro zone economy fail. At that point, they argue, additional finance policy measures should be negotiated at the European level.

In the opinion of the economists, the two stimulus programs already passed with investment projects, the sinking of taxes and the reduction of social security payments are already measures taken that could lead to mid-term growth. They said it was reasonable to use deficit spending to finance those measures. At the same time, they criticized Berlin's much-vaunted scrapping premium to spur new-car sales, saying it would only promote short-term spending. They also called on the European Central Bank to lower its key interest rate to 0.5 percent from the current 1.25 percent.

Government officials have been reserved in their predictions. Economics Minister Guttenberg said it's possible the economy could bottom out by winter. But the corner still might not be turned even then, he said. Both Guttenberg and Steinbrück warned that economic predictions have become less reliable in the current climate. Steinbrück said he believed the dark forecasts of economists had been partly responsible in the past for making the economic climate even worse.

Steinbrück said the crisis remained primarily a banking crisis. Inter-bank loans, the mutual extension of credit, still aren't working as it should because of a lack of trust, he said, explaining that the situation is making it very difficult for businesses to get refinancing. Nevertheless, in macroeconomic terms, he said there was no credit crunch.

In two weeks, the German government is expected to present its plans for creating so-called bad banks in order to free financial institutions of their toxic assets, which are threatening existing capital as well as the supply of loans to the business world. If trust still cannot be restored after the creation of the bad banks, and if the two economic stimulus packages already approved do not produce the desired effect, calls for a third package will likely increase.