German Car Makers Would Lose Big From Euro Death

“it will be a good idea to bail out Spain, because if Spain quit, it would more or less mean that the euro would shrink to be a currency including France, Germany and Italy, so that’s not a real option”

You could be forgiven for thinking that the euro is about to collapse, as you watch Greek riots and Irish protests on the nightly network news. Now the spotlight is moving towards Spain, a much bigger and more important economy, and the telephone book numbers involved become all the more difficult to comprehend. The BBC, Britain’s state-controlled broadcaster, was reporting this morning that the latest fund-raising to prop up tottering Ireland might cost another 15 billion euros ($20 billion) but if Spain came under pressure it would take 10 times that amount of money to keep its head above water.

Despite the fact that the European Union (E.U.) – the euro is the currency invented by the E.U. as part of its policy to become a proper country like the U.S. – has a 750 billion euro rescue package ready to back any member state whose economy looks like failing, the markets don’t seem to be convinced and the pressure mounts on the so-called PIGS; that’s Portugal, Ireland Greece and Spain.

Every time the crisis rears its head, the media reports that it is the poor old German taxpayer who is being called on again to fund bailouts. The question is, how long will Germany, Europe’s biggest and most successful economy by far, be prepared to throw its hard earned taxes to bailout profligate countries like Greece and Ireland which use other people’s money to provide early retirement packages and welfare state benefits they can’t afford themselves.

The answer is: for the foreseeable future.

The reason: Germany industry in general and its automotive business in particular benefits massively from being a member of the E.U. and using the euro to price its exports. If the euro collapsed and Germany had to revert to its old currency, the mark, its car industry would take a price hit of perhaps 25 per cent. If Germany was forced to revert to the mark, car manufacturers would quickly have to move production out of high wage Germany, causing huge unemployment. To a degree this is happening already, but this would become a disruptive and politically unacceptable stampede if the mark was called off the bench and the euro dumped.

Sell it to the Germans
“Whether Germany is willing to pay more for more bailouts ultimately depends on whether German politicians can sell this to the German people,” said Professor David Bailey of the Coventry University Business School.

“There is a good argument (for Germans) for supporting peripheral Eurozone countries because Germany – via the euro – has had a huge boost to its competitiveness,” Bailey said.

Even before the euro when Germany’s currency was the mark, the country racked up huge trade surpluses. After it joined the euro on January 1, 1999, it was presented with an effective devaluation, although this has fluctuated over the years as it strengthened and weakened against the dollar.

“With the euro it has run huge trade surpluses but its currency was fixed via its euro zone partners, giving it at least – say – a 20 to 25 per cent competitiveness boost. No wonder German manufacturing – and its car making industry – is doing well and why Germany would want to stay part of the euro zone,” Bailey said.

While many major global economies are stuttering and struggling to move out of recession, Germany has been booming. Germany’s gross domestic product in the third quarter rose a net 0.7 per cent and by 3.9 per cent compared with the same period of 2009.

Export-led
Economists called this an export-led rebound, and said things would get even better for Germany because the nervousness surrounding the euro was weakening the currency and boosting its sales outside Europe. Germany’s car manufacturing association reckons that the country’s auto exports will increase 21 per cent this year to 4.15 million, while German vehicle output will jump 10 per cent in 2010 to 5.45 million. German manufacturers are also reaping the benefits of tough rationalization programs begun when the recession struck.

German car manufacturers have been increasing their production outside of the country to try and insure against currency volatility. Volkswagen, Mercedes and BMW all have factories in the U.S. Last month BMW said it was raising output at its Spartanburg, S.C. plant by 50 per cent to 240,000 a year next year. All the main German manufacturers produce a hefty percentage of output outside of the country, but not surprisingly the bulk of output is still at home.

Professor Ferdinand Dudenhoeffer of the Center for Automotive Research at the University of Duisberg-Essen says there’s no way that the euro will die.

“I think the chance that the euro will really crash is zero. Germany has a big interest to keep the system, for different reasons,” Dudenhoeffer said.

He said it is important for Europe to remain strong for the euro to continue. If the euro died and European countries reverted to their old currencies, this would weaken them all, and make them vulnerable to challenges from the likes of China and India.

“We will find solutions (to the euro problem) even if it hurts,” he said.

Natural hedging
Even if the euro survives, German car companies will have to continue to spread production around and out of their home country. Some car makers like luxury sports car maker Porsche have used financial instruments to insure or hedge their revenues against currency fluctuations. Others use so-called “natural hedging” to do this, which simply means installing production in foreign countries like the U.S. so that when currencies fluctuate, production can move around in response to protect profit margins.

“German car makers currently produce 50 per cent of their cars in Germany. VW is just producing 24 per cent of its cars in Germany. And this will rapidly change in the next years. Possibly we will arrive at 35 per cent of sold cars produced in Germany. The risk is manageable. Natural hedging of car makers will become more important and that we reduce risks further. So even if the unthinkable happens, we will not be in a situation which is basically jeopardizing the German car industry,” Dudenhoeffer said.

Professor Stefan Bratzel of the Center of Automotive Management in Bergisch Gladbach, Germany, agrees that German production would be quietly on the move even if there was no euro crisis. Bratzel isn’t keen on the prospect of the euro’s demise.

“It is important for German manufacturers to keep the euro and there are no good options for returning to the mark. We have profited enormously from the euro currency because a great share of German production goes to European markets. All the German manufacturers will of course try to convince our Chancellor (Angela Merkel) to bail out countries like Greece, Ireland, Portugal. I think it will be a good idea to bail out Spain, because if Spain quit, it would more or less mean that the euro would shrink to be a currency including France, Germany and Italy, so that’s not a real option,” Bratzel said.

Coventry University’s Bailey thinks it’s a no-brainer for Germany. It will move heaven and earth to retain it.

Bailouts versus revaluation
“Withdrawal by Germany would remove the cost of bailouts but would mean a hefty appreciation of its currency and loss of competitiveness for its traded sector. Short term that would mean reduced output and job losses. Longer term it would relocation of Labor-intensive activities (e.g. assembly) abroad and more job losses.”

“So while selling bailouts back home may not be popular, a eurozone collapse and revaluation of Germany’s currency, with all that this implied, could well be even more unpopular for Germany,” Bailey said.

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Neil Winton – December 3, 2010