The Gift Cheap Oil, an Invitation to Spend

The oil price crash is like a massive tax cut for Germany, argues asset manager Dieter Wermuth.
In Germany, the living is easy right now.

If the oil price stays where it is, Germany's annual import bill for energy will be a lot lower than anticipated not long ago.

I do not know of any forecast that predicted $41 for a barrel of oil from the North Sea. That means, a key assumption behind the consensus outlook for GDP growth simply does not hold any longer.

As a net importer of oil and gas, recent developments have, on balance, been excellent news for Germany. I am certain that GDP forecasts for this year and next will be revised up.

In the twelve months before the oil price began to collapse in July 2014, the country spent €127 billion on energy from abroad. In the coming year, the bill will be only €60 billion if the oil price stays where it is right now, a saving of no less than 2.2 percent of a year’s GDP.

It is akin to a gift from foreign energy producers such as Russia, Norway or the OPEC – like a big tax cut that is not accompanied by rising government debt.

The best outcome for the euro zone as a whole would be a low oil price, combined with a weak exchange rate and a booming German economy – which is the largest importer of euro zone goods.

Consequently, the purchasing power of households, businesses and the state increases by this amount, which in turn will not only boost the demand for goods and services but also the demand for labor. Full employment is likely on the cards.

In the event that the euro is rediscovered as a safe haven, now that the Greek crisis no longer poses an immediate threat to the currency’s future anymore, the annual savings for imported energy could be even larger than the 2.2 percent of GDP.

But there is an obvious downside to this. A stronger euro exchange rate brought about by capital inflows reduces the international competitiveness of German firms and thus the stimulus provided by an undervalued currency.

In the second quarter of 2015, real domestic demand actually declined by 0.3 percent. Had it not been for the 0.7 percentage point contribution to GDP growth from foreign trade (i.e. net exports), the outcome would have been negative, rather than the plus 0.4 percent reported by the Federal Statistical Office.

As it is, Germany can live quite well with an appreciating exchange rate, but for the other member states of the common currency it could mean that one important means of supporting their recovery disappears.

In other words, the best outcome for the euro zone as a whole would be a low oil price, combined with a weak exchange rate and a booming German economy – which is the largest importer of euro zone goods. A strong economy means strong demand for imported goods. The risk that this could end badly, in the form of an uncontrolled wage-price spiral, is almost non-existent as the rates of capacity are still very low while average unemployment is in the order of 11 percent. Firms have a hard time raising their prices, just as workers have problems pushing through higher wages. Without wage inflation there will be no general inflation.

In any case, deflation is today’s problem – not inflation. Lower energy prices will contribute to even lower headline inflation, which in Germany and indeed the whole euro area is already not far from zero. The objective of the European Central Bank to reach its “just-below-2-percent” target will be that much more difficult to realize.

Never have monetary conditions in Western Europe been as accommodating as they are today, yet the real economy has not responded as it should. These days, for various fundamental reasons, the ECB appears to be pushing on a string.

It is therefore time to discuss alternative means of promoting economic growth in the euro area. Lower oil prices will considerably increase fiscal policies’ room for maneuver, especially in Germany where the state’s overall budget surplus (!) has been no less than 1.4 percent of GDP in the first half of this year.

What is happening here? Why does Wolfgang Schäuble not realize that it is necessary to adopt a significantly more expansionary borrow, tax and spend policy?

In terms of the government budget he certainly has the means to implement such changes, at least while long-term interest rates remain at rock bottom levels.

It is after all in a creditor country’s best interest to create conditions in which borrowers are most able to sell their products; they need revenues from exports to service their debt.

But if Germany continues to tighten its belt, the euro is doomed – and financial claims against the other countries must be written off.

There are some early signs that these basic facts are being recognized. But the numbers being discussed are quite small in relation to the huge output gaps in the euro area. It looks as if the stimulus could be too small and come too late.   


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