Global Economics

The Financial Crisis Hits German Economy


Germany is whacked by falling demand for everything from travel to machine orders as well as shattered confidence and curtailed financing

The turmoil in the financial markets has reached Germany's real economy with horrifying speed. It is beginning to affect ordinary people, as both investors and employees, and it is already having an impact on German companies. The only remaining question is: How brutal will it get?

In the end, even prayers didn't help. The €4.3 million ($3.1 million) had simply gone up in smoke. That was the sum the Oldenburg State Church had invested with the failed American investment bank Lehman Brothers.

The church, which includes 123 congregations between the northern German town of Cloppenburg and the North Sea port of Wilhelmshaven, was looking for higher returns than it could earn with the dull government bonds in which it normally invested its money. To increase the church's profits, the Protestants' financial experts used some of their assets to buy Lehman securities.

Now the bank is bankrupt, and the faithful have become creditors—as well as the witnesses of a miraculous transformation—that of money turning into thin air.

At least the church is not alone in its troubles. Only a relatively small number of Germans invested in Lehman securities or had their money deposited with the currently insolvent Icelandic Kaupthing Bank. But since the first German savers lost money they had believed to be safe, it has been clear that the economic quake that began in the US real estate market more than a year ago, and then spread to Great Britain, Spain and Iceland, has now hit Germany, the world's leading exporter.

The German economy is considered relatively immune to crises in individual markets. Many companies in the machine building, medical and environmental engineering sectors are the undisputed world market leaders in their industries. Because their goods are in demand everywhere, German companies have, until now, felt secure in the knowledge that if sales to the United States or other European countries decline, they could offset the shortfalls by increasing sales to China, India and Russia.

But the current crisis is different, affecting companies in various ways. It is not just a sales volume crisis brought on by consumers and other companies ordering fewer products. It is also a financing crisis, because customers interested in buying goods lack the necessary capital, now that the banks have curtailed lending. And it is also a crisis of confidence, in which those who could buy goods are no longer interested in doing so.

When consumption drops off, companies must cut additional jobs, the markets decline and a vicious cycle of self-fulfilling poor prospects begins. In this way the financial crisis, which had seemed like more of a virtual crisis to ordinary citizens, is becoming a real, palpable drama.

Crisis-Related Cold Feet

In machine building, Germany's most important industry, with its 950,000 employees, customers are cancelling orders. Sales are declining in the automobile industry. To offset the drop in demand, Opel, Ford, BMW and Mercedes-Benz have taken to closing some of their plants for weeks at a time.

Software maker SAP, based in the southwestern German town of Walldorf, has reacted to a decline in demand with a hiring freeze. Publishing houses, like Gruner & Jahr, affected by declining advertising sales, are following suit. Lufthansa is seeing declines in its business travel and cargo business. Real estate brokers report that some customers are even canceling closings at the last minute, either because of crisis-related cold feet or banks changing their minds about previously approved mortgage loans.

This is Germany in the autumn of 2008.

Things are already so bad that it sounds optimistic when Bert Rürup, the head of the German government's economic advisory council, says that he cannot rule out the possibility that the German economy could slide into a recession.

On Tuesday the leading economic research institutes in Switzerland, Austria and Germany presented a joint report to the German government. The report concluded that Germany can only expect miniscule growth of 0.2 percent for 2009. And for the first time in many years, they are predicting rising unemployment figures for next year.

Even Hans-Werner Sinn, the head of the Munich-based Institute for Economic Research (IFO), notes that the situation is "extremely worrisome." Gustav Horn, a German economist with ties to trade unions, sees a "global recession" looming.

Fear of the future is already shaping the behavior of citizens. Many have decided to put off costly purchases, including such luxuries as expensive vacations and more mundane purchase decisions like replacing an older refrigerator. According to Germany's Federal Statistical Office, retail sales declined by 3 percent in August. The Society for Consumer Research expects a lackluster Christmas shopping season.

Tragically, citizens' concerns about the future threaten to accelerate the very economic downturn they fear. As a result, it is not likely to be long before the crisis affects the labor market.

Labor statistics put out by the Federal Labor Office in Nuremberg are still favorable. In fact, Frank-Jürgen Weise, the head of the agency, expects the number of unemployed to fall below the magic number of 3 million in October, for the first time in 16 years. But there are growing signs that this will be the last piece of good news for some time to come.

Temporary workers are always the first to go. "We have been noticing since May that our business is getting more difficult," says Ingrid Hofmann, the managing director of the employment agency of the same name. She currently employs 12,000 temporary workers. But some of those workers, who had been sent to work for carmakers and their suppliers, have been coming home early lately.

Machine building and plant construction, two of the most stable pillars of the German economy until now, could be especially hard-hit. The industry exports two-thirds of its domestic production. But banks in Europe and the United States have cut back on lending so drastically that the customers of machine builders are finding it more and more difficult to secure the financing they need. As a result, orders are not being placed anymore or are being cancelled at the last minute.

Koenig & Bauer, a manufacturer of printing machines, is already feeling the effects. At the DRUPA printing industry convention in Dusseldorf this spring, the company collected orders worth €170 million ($233 million). But then customers cancelled orders totaling double-digit millions, because they were unable to obtain financing. Orders for another €50 million ($69 million) were at least temporarily suspended.

The company, which has been very profitable in recent years, could even slide into the red in 2008. And because there is no improvement in sight, "we will have to adjust capacity," says Klaus Schmidt, the head of marketing. This is simply management speak for the fact that 700 jobs will probably be cut domestically and abroad. According to Schmidt, this is a not a problem specific to Koenig & Bauer, but one that affects the entire industry.

The entire export sector is coming under pressure. German exports declined by fully 2.5 percent in August alone.

Part 2: A Stress Test for Companies

Companies like construction machine manufacturer Komatsu will also feel the effects of the slowdown. Around 900 employees at its plant in the northern German city of Hanover assemble excavators and wheel loaders, which are then sent to Spain, France, Italy, England and Germany.

But when construction slows to a near-halt in countries like Spain, now that its real estate bubble has burst, construction machines are no longer needed. The few growth markets in Eastern Europe can no longer offset these declines.

"If the market in Romania grows by 50 percent, we're talking about no more than 100 machines," says Wilfried Tschich, the managing director of Komatsu's German subsidiary. "But a 50-percent decline in the market in Spain corresponds to about 1,000 machines."

Mercily Exposing Weaknesses

The consequence is a drastic reduction in the number of overtime hours worked at Komatsu, which in turn means that the temporary workers' contracts are not renewed. The slowdown could eventually affect the company's full-time employees.

In this way, the crisis is slowly eating its way through the German economy. It is a stress test of sorts for companies and will mercilessly expose their weaknesses.

Especially vulnerable are those companies that in recent years have fallen victim to private equity firms, the corporate raiders that have come in for sharp criticism in Germany. Some of the companies they now own include the television group ProSiebenSat.1, bathroom fixture maker Grohe, fashion giant Hugo Boss, auto parts maker Unger and Cognis, a former subsidiary of consumer products giant Henkel.

A time bomb is ticking within all of these companies, because the financial investors acquired them to a large extent with loans, which they subsequently unloaded onto the companies. The hijacked companies have been forced to take on debt to be able to distribute dividends to their new masters.

Until recently, there was a surplus of cash on markets worldwide, which meant that cash was cheap. But in an economic downturn, companies will have trouble servicing the interest for their new loans.

The dangerous point will come when the loans mature and the companies are forced to look for new financing. Jan Moulton, the founder of the British financial investment firm Alchemy Partners, says: "There will be collapses of large companies in the hands of private equity groups. That is absolutely guaranteed."

Other companies, even those seen around the world as the pearls of German industry, could also end up in serious trouble, companies like BMW or Daimler. Despite being successful for years, the financial crisis is also eating away at the foundations of their business.

Both companies have almost doubled their car sales in recent years. Their customers didn't seem to mind that the new models kept getting bigger and more expensive. By offering attractive leasing and financing terms from their own banks, the manufacturers ensured that their sedans and SUVs remained affordable. Mercedes-Benz already finances the purchase of one in three vehicles worldwide, while BMW finances one in two.

But if the car companies are forced to charge their customers higher interest rates in the future because they too will be paying higher rates, this could jeopardize the entire business model. This would threaten growth and, ultimately, the companies' independence.

Only by sharply increasing sales could German carmakers, which are relatively small by international standards, earn the billions they urgently need for investments in new engine technologies. This creates growing pressure on Daimler and BMW to work together.

"I don't want to rule anything out at this point," says one Daimler manager. The drastic decline in the stock prices of both companies could even force them to aim for cross-ownership as a protection against hostile takeover attempts.

Much of these anticipated problems are just that: anticipated. At this point, no one can predict the true consequences of the financial crisis. Which is precisely what makes executives so nervous. They can handle an economic crisis—by streamlining, cutting costs and increasing their competitiveness. But how are they supposed to react when all financial markets are in turmoil at the same time?

The German economy still tends to be structured in a more stable way than that of the United States or Great Britain. German industry is not focused on one or two sectors. For this reason, there are enough companies that do not fear a sharp decline in their business, including energy companies, the chemical industry and pharmaceutical manufacturers. But how much longer will these companies be able to avoid the vortex?

There is only one thing that corporate CEOs currently enjoy from their offices in their companies' headquarters buildings: a clear view of the foggy wall of the crisis and the certainty that whatever it conceals cannot be good.

One example is the Mercedes World showroom on Berlin's Salzufer. The giant, €40 million ($55 million) cathedral to consumption, is populated almost exclusively by salespeople these days. The Formula One simulator is abandoned, and the child care center is as quiet as a graveyard.

They are under massive pressure, says one salesman, whose shoes are so shiny that they reflect his desk lamp. "Those who bought an eight-cylinder car in the past order a six-cylinder today. And the former six-cylinder customer now prefers a four-cylinder car." If he orders a car at all, that is.

Some do what Gerald Heese does. The 59-year-old resident of Berlin's Spandau district plans to buy a Mercedes SLK in silver—but this one is a toy car for his nephew.


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