The official food ration issued by the occupying powers (as Germany got divided into four zones between Britain, France, the United States and the erstwhile Soviet Union) ranged between 1,040 and 1,550 calories per day, and food output per capita was barely 51% of its level in 1938. Moreover, industrial production in 1947 was only a third of what it was in 1938, and a sizable portion of working-age German men were deceased during the war.

However, 20 years later, most of the world was envious of West Germany’s prosperity. At the time, analysts believed that West Germany would have to be the largest beneficiary of the American welfare state. The German economic miracle, or Wirtschaftswunder, became a topic of discussion.

The currency reform and the abolition of price controls, which took place over a few weeks in 1948, highlighted the miracle. In addition, the lower marginal tax rates in 1949 and 1948 also bolstered growth.

Before
By 1948, the German people had endured nine years of rationing and price restrictions. For his government to purchase war supplies at artificially low rates, Adolf Hitler placed domestic price controls in 1936. Later, in 1939, Hermann Goering, one of Hitler’s most important Nazi appointees, enacted rationing.

United States, France, Britain, and the USSR joined to form the Allied Control Authority, which decided to maintain the price controls and rationing instituted by Hitler and Goering. Additionally, they kept up the recruitment of labour and other resources by the Nazis.

A “zone” of German land was under the jurisdiction of each Allied administration. The cost of living index in the American zone in May 1948, calculated at controlled prices, was only 31% higher than in 1938. The total amount of money in the German economy in 1947, including currency and demand deposits, was five times higher than in 1936. There had to be shortages because prices had only slightly increased while money had multiplied.

Food shortages became so severe due to price limitations that some people began producing their food while others made weekend trips to the countryside to barter for food.

Swaps in business-to-business transactions were so common that many companies engaged “compensators,” who were experts in exchanging their company’s output for necessary inputs by engaging in numerous transactions. According to estimates made by American military analysts in September 1947, between one-third and 50% of all commercial transactions in the bilateral area (the US and British zones) took the form of “compensation trade” (also known as barter).

Bartering could have been more efficient than a pure cash purchase of goods and services. But, according to German economist Walter Eucken, the economic model had been “reduced to a primitive condition.” The statistics support him. Bizonal production in March 1948 was just 51% of what it had been in 1936.

The argument
Eucken founded the Soziale Marktwirtschaft, also known as the “social free market,” a school of economic theory with its headquarters at the University of Freiburg in Germany. Members of this school detested authoritarianism and voiced their opinions under Hitler’s rule, sometimes at significant personal risk. The school “represented an intellectual resistance during the Nazi period, requiring great personal courage and the independence of the mind,” according to Henry Wallich.

School members supported free markets, minimal advancement in the income tax system, and antitrust laws to restrain monopolies. Before the war, cartels were explicitly legal in Germany. The Chicago school’s young members, Milton Friedman and George Stigler, shared that it was similar to the Soziale Marktwirtschaft. It supported strong free markets, a small amount of government redistribution through the tax system, and antitrust laws to avoid monopolies.

Wilhelm Röpke and Ludwig Erhard were students at the German school. Röpke promoted price restrictions’ elimination in addition to currency reform to bring the amount of money in circulation in line with the number of products. He reasoned that both were required to put a halt to controlled inflation. The currency reform would put a stop to inflation, and price decontrol would put an end to repression.

Röpke and Ludwig Erhard concurred. During the conflict, Erhard had penned a letter outlining his idea of a market economy. He made it plain in his memo that he wished to stop the Nazis.

On the other hand, the Social Democratic Party (SPD) favoured maintaining governmental dominance. Dr. Kreyssig, the principal proponent of central government control over economic policy for the SPD, stated in June 1948 that decontrolling prices and implementing currency reform would be futile. Labour union leaders, British authorities, most West German manufacturing interests, and some American authorities supported the SPD.

The shift
Ultimately, Ludwig Erhard prevailed. Erhard, whose anti-Nazi sentiments were evident, was chosen as Bavarian minister of finance in 1945 because the Allies wanted non-Nazis in the new German government. In addition, he was a military advisor to U.S. General Lucius D. Clay while serving as the bizonal Office of Economic Opportunity director starting in 1947.

On Sunday, June 20, 1948, Clay and his French and British counterparts implemented a currency reform following the Soviets’ withdrawal from the Allied Control Authority. The basic plan was to replace reichsmarks with a significantly smaller quantity of Deutsche Mark (D.M.), the new legal tender. This would dramatically reduce the money supply, leading to fewer shortages even at the controlled prices—now stated in Deutsche marks.

The currency reform was highly complicated, and many people saw a significant decline in their net worth. In addition, the money supply decreased by around 93% due to the whole situation.

The German Bizonal Economic Council passed a price decontrol ordinance that same Sunday, at Ludwig Erhard’s urging and against the wishes of its Social Democratic members, allowing and encouraging Erhard to do away with price limits.

De-Nazifying the West German economy was Erhard’s summer project. According to the Federal Reserve Bank of New York economist Fred Klopstock, “It followed the directive removing price, allocation, and rationing regulations” from June through August 1948.

Nearly all manufactured items, including fruits, vegetables, and eggs, were exempt from regulations. As a result, many remaining limitations were removed, and ceiling prices on many other things were raised significantly.

Naturally, Erhard was correct in his prognosis. Without a rationing system standing in the way, price decontrol permitted consumers to communicate their wants to sellers, and higher prices encouraged sellers to provide more.

The administration also lowered tax rates, reformed the currency, and released price controls. In a 1949 paper, a young economist named Walter Heller, who was then working for the American Office of Military Government in Germany and subsequently became chairman of President John F. Kennedy’s Council of Economic Advisers, outlined the improvements. According to Heller, Military Government Law No. 64 “cut a wide swath across the German tax system at the time of the currency reform” to “remove the repressive effect of extremely high rates.”

The corporate income tax rate was decreased from its previous range of 35 to 65% to a flat 50%. The top income tax rate for individuals remained at 95%. However, it only applied to income over DM250,000 per year.

In contrast, the Allies had imposed a 95% tax on all income over 60,000 Reichsmarks (about DM6,000) in 1946. With an annual income of just about DM2,400, the marginal tax rate for the average German in 1950 was 18%. If that same person had made the identical amount in Reichsmarks in 1948, he would have paid taxes at an 85% rate.

After
The economic impact on West Germany was tremendous. “The spirit of the nation changed overnight,” wrote Wallich. The drab, starving, lifeless figures pacing the streets in an endless search for sustenance came to life.

On Monday, June 21, stores were brimming with merchandise as individuals understood the money they sold their items for will be worth far more than the previous currency.

Additionally, absenteeism fell. Workers missed an average of 9.5 hours each week in May 1948, partly because their wages were meagre and partly because they were out foraging or haggling for food.

Average weekly absences decreased to 4.2 hours by October. As a result, the bizonal index of industrial production was barely 51% of its 1936 level in June 1948; by December, it had grown to 78%. In other words, there had been a greater than 50% growth in industrial production.

After 1948, the output grew exponentially more each year. By 1958, industrial production had increased more than four times from the six months in 1948, just before currency reform. As a result, industrial output per person tripled. Contrarily, the communist economy of East Germany remained stagnant.

Erhard became Germany’s first minister of economic affairs after Konrad Adenauer, the new Federal Republic of Germany’s first Chancellor, recognized the success of his ideas. He kept that position up until 1963, at which point he became chancellor, which he held until 1966.

Marshall Plan
Through October 1954, overall aid from the Marshall Plan and other aid initiatives was barely $2 billion. Even in 1948 and 1949, when it was at its highest, Marshall Plan funding represented less than 5% of Germany’s GDP. Germany outgrew other nations that received significant Marshall Plan help in growth.

Furthermore, while West Germany was getting aid, it paid far more than $1 billion in reparations and restitution. Last but not least, and most significantly, the Allies levied DM7.2 billion ($2.4 billion) in annual occupation costs against the Germans. Thanks to these occupation expenditures, Germany did not have to pay for its defence. In addition, Belgium recovered from the war the quickest and relied more on free markets than the other war-torn European nations.

Conclusion
What many observers mistakenly believed to be a miracle was not one at all. Ludwig Erhard and other members of the Freiburg school were aware of the harm that can result from inflation when it is combined with price controls and high tax rates, as well as the significant productivity gains unlocked by stopping inflation, eliminating rules, and lowering high marginal tax rates anticipated it. Erhard’s historical success can still be emulated by many struggling economies worldwide.

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According to the latest economists’ panel, jointly conducted by the Munich-based ifo Institute and the Frankfurter Allgemeine Zeitung, 71 percent of the German economics professors surveyed described Donald Trump’s influence on the global economy as negative while 64 percent stated that this also applied to the US economy.

“Trump remains a phenomenon: he cuts a remarkably poor figure in office, and yet the US economy is performing well. This may be because Trump has implemented very little of his political programme to date,” said Niklas Potrafke, who supervises the panel and is Director of the ifo Center for Public Finance and Political Economy.

The 130 German economics professors, who took part in the survey, were very critical of Trump’s policy across the board. His policies for healthcare, protecting the environment, maintaining peace and security were rated poorly in the survey. German economists also believe that Trump’s policies have negative implications for social justice. This was in line with most of the survey participants’ expectations.

They saw the implications of Trump’s policy for employment as more or less neutral; and assessed his influence on the economic climate somewhat more favourably, although still slightly negative. German economists clearly rejected Trump’s trade policy.

Survey participants expect the lower and middle-income earners to emerge as the losers of Trump’s policies while high earners stand to gain. The prevention of illegal immigration was the only area in which economists’ responses were positive on balance.

Many German economists dislike Trump’s style, which was described by several survey participants as ‘disastrous’.

The measures taken by the Trump government are ‘airy-fairy, contradictory and naïve’ writes the trade economist Rolf Langhammer.

The Freiburg-based finance expert Bernd Raffelhueschen, by contrast, favours a more relaxed approach to Trump’s policies. In his view, things are rarely as bad as they seem.

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The result gives Merkel her fourth term as German chancellor.

Even though the CDU/CSU are ahead of the other parties, their performance is the worst in several decades. The German Bundestag has 630 seats. The CDU/CSU will get just over 240 seats.

Their coalition partner SPD will get over 150 seats, but chairman Martin Schulz said the outcome meant the end of the ‘grand coalition’ that has been in power since 2013. Deputy party leader Manuela Schwesig believes that the mandate is for them to sit in the opposition. If they don’t, the AfD will become the leader of the opposition.

The performance of the AfD has caused concern among Germans. It is the first time that a far-right party will get seats in the Bundestag. The votes came from the people who were unhappy with Merkel welcoming refugees. After the results were declared, some people took to the streets of Berlin shouting slogans that refugees are welcome.

Merkel quickly addressed the people who voted for the AfD. She promised to listen to their ‘concerns, worries and anxieties’ and get them back to the CDU/CSU.

But right now, with the exit of the SPD, she will need coalition partners. The options are the liberal Free Democratic Party (FDP) and the Greens. While the FDP might be amenable to working in the government, the Greens could pose a challenge as their policies clash with that of the government.
Merkel needs more than a simple majority to push through her agenda for Germany and Europe. Industry leaders have already voiced concern about the fractured mandate and are asking for stability.

Fourth term
Following the 2005 election, Merkel was appointed Germany’s first female Chancellor at the head of a grand coalition consisting of the CDU, its Bavarian sister party, the Christian Social Union (CSU), and the Social Democratic Party of Germany (SPD). In the 2009 federal election, the CDU obtained the largest share of the vote and Merkel was able to form a coalition government with the support of the Free Democratic Party (FDP). In the 2013 federal election, Merkel’s CDU won a landslide victory with 41.5% of the vote and formed a second grand coalition with the SPD after the FDP lost all of its representation in the Bundestag.

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The DAX, Germany’s top stock index, was nearing the red after shares in the country’s largest car makers dropped over a fresh probe into the diesel emission scandal.
Eurozone stock markets have felt the pain of a strong currency in recent weeks, as investors think that improving economic data will force the ECB to curtail its bond-buying program prematurely and — if inflation picks up — lead to interest rate hikes.

But the DAX 30, the key German stock market index, now has an additional problem that has contributed to recent falls. Its motor sector — led by BMW, Daimler and Volkswagen — is under a cloud as more jurisdictions line up to fine the companies over diesel emissions.
Last week, the Mayor of London announced plans to seek compensation from Volkswagen after the true scale of the company’s diesel-fuelled cars’ contribution to the city’s air pollution became known. The sector is at risk of punitive fines across the world.

A further risk is that the ‘Made in Germany’ brand suffers more generally.

However, while this is embarrassing for the German auto sector, and for German exporters more generally, it is likely to be a passing phase. The fines will be absorbed by shareholders, and meanwhile the German auto sector will return to the real long-term battle: is there a durable market for high quality, driver-driven, private cars?

Also Read: Germany’s business index hits record high

German — and European autos’ biggest threat comes from technology from the US — in the form of driverless cars and battery cells, amongst other factors – as well as changing social habits, which include car pooling and young adults driving less in developed economies.

The German stock market crash is a timely reminder of the need to broadly invest so that portfolios will have exposure to the young companies likely to benefit from driverless cars for example.

Diversification of portfolios across sectors, asset classes and regions will ensure investors are best-placed to take full advantage of the present and future opportunities and to mitigate the risks.

Tom Elliott is International Investment Strategist at deVere Group

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Notably, the economy has shown improvement despite the absence of any new structural reforms for years.

In manufacturing, the index hit a new record high. Manufacturers expressed greater optimism about the short-term future. Capacity utilisation rose significantly by 0.7 percentage points to 86.7 percent, the highest since late 2008.

In wholesaling, the business climate improved again on the back of far more optimistic expectations. But, assessment of the current business situation came down from the record high in June. In retailing, the index dropped. Retailers were far less satisfied with their current business situation. Their optimism about the short-term business outlook is also not encouraging. Nevertheless, at present, they remain at a very high level.

In construction,contractors are happy with their current situation and expect business to pick up in the coming months.

Overall in industry, the combination of strong orders and low inventories is as good as in mid-2006 and late-2010.

But even as the domestic economy gains momentum, factors abroad may pose a few risks — protectionist measures by the US, a weakening of the UK economy in the wake of Brexit negotiations and a slowdown of the French economy.

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January 19, 2017: Global alternative asset manager The Carlyle Group (NASDAQ: CG) announced on January 16 that it has agreed to acquire a significant stake in Africa’s largest credit rating agency Global Credit Ratings (GCR) from the management, founders and German development financial institution DEG. Following the transaction, Carlyle will be the largest shareholder, with around half the equity in the company while management and DEG will remain invested in the business.

Funding for this investment will come from the Carlyle Sub-Saharan Africa Fund. The transaction is expected to close in early 2017, subject to regulatory approvals.

With its headquarters in South Africa and operations across the continent, GCR is Africa’s largest provider of credit ratings. The company serves 400 customers across 20 countries and is the only rating agency to have a strong presence in multiple geographies across the continent.

GCR provides a range of analysis and rating services to its customers, which include many household names and blue-chip organisations. It caters to four key sectors – insurance, financial institutions, corporate & public sector entities, and structured finance.

Eric Kump, co-head of the Carlyle Sub-Saharan Africa team, said, “We are excited to invest in GCR and work alongside CEO Marc Joffe and a top-class management team and staff.  Over the past 20 years, the management team have worked hard to grow the business into the highly-respected and pan-African organisation it is today. We will work with the management to continue the impressive growth they have achieved in recent years.  We are delighted to be able to bring our strong African experience while also leveraging our global expertise in this sector, through our investment in DBRS, an international credit ratings agency headquartered in Toronto, Canada, to assist with further geographic expansion.”

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IFM Correspondent

November 24, 2016: European Parliament leaders told London’s Brexit negotiator on Tuesday that Britain should expect to be shut out of cooperation in areas it values once it leaves the European Union.

David Davis met Guy Verhofstadt, the EU legislature’s lead Brexit negotiator, and Manfred Weber, a conservative ally of German Chancellor Angela Merkel who leads the biggest bloc in the parliament.

The meetings are part of preparations before Prime Minister Theresa May starts negotiating in March under Article 50 of EU treaty.

Weber voiced impatience with a lack of clarity from May on what she will ask for.

He said a suggestion from Davis that Britain remain in or closely tied to the EU’s single market while rejecting free immigration by Europeans or the oversight of EU courts was not workable.

“Brexit means Brexit,” he said in Strasbourg, echoing May’s famously opaque definition of what her government will ask for following the June referendum vote to leave the Union.

“I see a British government that keeps saying where it wants to cooperate closely and not how it wants to leave the European Union,” he told reporters after meeting Davis.

He said Davis voiced an interest in maintaining economic ties and also close cooperation in areas such as justice and criminal affairs.

“So I must stress again: Brexit means Brexit, that means leaving the European Union, that means cutting off relations … and not cherry picking, not special relationships,” Weber said.

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Suparna Goswami Bhattacharya

September 26, 2016: Though talks of the adverse after-effects of Brexit have been going on for a while, things have not been as bad for the country as was predicted, at least for now. In fact, the adverse impact in the short term has been lesser than initially feared.

Markus Kuger, Senior Economist, Dun & Bradstreet, expects the British economy to continue to grow throughout the 2016-18 period as the underlying pillars of growth remain intact.

“At the moment, the British economy is more price competitive in global markets, thanks to the depreciation of the pound. Hence, it does not come as a surprise that businesses selling abroad are doing well. However, the fact is that UK currently is still in the EU and if it were to lose access to EU markets, the introduction of tariffs and other regulations could counterbalance this development,” he says.

The UK economy will get a further boost on the policy front from the Bank of England (BOE). The BOE’s move to cut back interest rate alongside reviving quantitative easing and other measures will help the economy chug along for a while, says Howard Archer, Chief European and UK Economist, IHS Global Insight. “On the fiscal front, some stimulus measures will likely be announced later in 2016 now that the government has dropped its plans for a fiscal surplus by fiscal year 2019/20. This could include increased infrastructure spending,” remarks Archer.

In fact, London continues to enjoy its position as the preferred destination for businesses. A recent study by PwC states that London has maintained top spot as a centre for business, finance and culture — widening its lead over 30 international cities. London’s success is consistent across all of the indicators — city gateway, economic clout, intellectual capital and innovation categories, and technology readiness. There are ample reasons why London will not relinquish its financial hub status overnight. These include English language, the time zone, the pro-business and well organised regulatory environment, a relatively stable economy, efficient transport infrastructure, office space availability and its cosmopolitan and desirable lifestyle.

However, experts warn that the ambiguity surrounding the new rules and regulations post Brexit is hampering London’s image. “Financial services companies can’t afford to wait for negotiations to complete. They have to plan their strategy to develop their European operations,” opines Nigel Green, founder and CEO, deVere Group. There is a fear among UK banks of losing their passporting rights, which will mean that they would need individual country licences in order to operate in the EU.

While large scale redundancies are not expected, there will definitely be gradual downscaling in London with expansion occurring in Frankfurt, and the new emerging hubs like Dubai. Negotiations are also not expected to settle soon.

“The EU refuses to hold informal talks before Article 50 is invoked and negotiations won’t begin until early next year. Both the UK and EU will have two years of limbo with the outcome largely unknown,” says Kuger.

Article 50 of the Lisbon treaty sets out how an EU country might voluntarily leave the union.

There will also be vast political uncertainty with the parliamentary elections due in France, Germany and Holland, to name just a few.

Kuger adds that the EU will not allow the UK to have their cake and eat it too. The situation for the EU is easy – access to the single market is impossible without the UK agreeing to free movement.

“The UK on the other hand faces a tough balancing act: they cannot have access to the single market while also restricting migration. While it’s in the EU’s interest to maintain and continue trading with the UK, the EU holds the upper hand in the upcoming negotiations,” feels Kuger.

The EU is transparent in saying that you can’t cherry pick between passporting rights and free movement of labour. If the UK does not want unlimited migration from the EU, it cannot have financial passporting rights.

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Suparna Goswami Bhattacharya

September 15, 2016: Recently, the German economy minister had remarked that Britain must not be allowed to ‘keep the nice things’ that come with EU membership without taking responsibility for the fallout from Brexit. In fact, he warned that if the issue is not handled properly, other members in the European Union may follow Britain’s lead.

“If we organise Brexit in the wrong way, then we’ll be in deep trouble, so now we need to make sure that we don’t allow Britain to keep the nice things, so to speak, related to Europe while taking no responsibility,” Sigmar Gabriel had said.

Economists agree with him. Since the June 23 referendum, all eyes have been on Germany to figure a way out for other members of the EU.

Jan Hatzius from Goldman Sachs says that France, the Netherlands, and the Czech Republic are already clamouring for referenda of their own. If Brexit proves less painful than expected, this might make Frexit, Nexit, or Czexit look more appealing. “In turn, such campaigns could raise renewed questions about the future of the Euro area that might necessitate much more aggressive ECB intervention,” says Hatzius.

Danae Kyriakopoulou, head of research, Official Monetary and Financial Institutions Forum (OMFIF), says, “Gabriel’s remarks echo the sentiment of many European leaders who want to avoid a situation whereby the UK is allowed to keep those parts of the EU arrangement that suit it without making any concessions in return. Such an approach would set a dangerous precedent for the cohesion of the EU and the future dynamics within the union.”

UK Prime MInister Theresa May is not likely to begin talks with EU before the end of the year. EU leaders do not want to give Britain the freedom to choose what it wants, like access to the bloc’s single market of 500 million consumers, while dispensing with EU principles, such as the free movement of people.

German Chancellor Angela Merkel’s receding power further complicates the European Central Bank’s growth policies and strengthens Britain’s negotiating leverage in the psychological and economic battle over the UK’s European Union withdrawal. The anti-immigration, anti-euro Alternative for Germany (AfD) forced Merkel’s ruling centre-right Christian Democratic Union into third place in elections in the eastern state of Mecklenburg Vorpommern.

Merkel’s humiliation in her electoral home region, especially the rejection of her liberalism on refugees, gave victory to the Social Democrats, the chancellor’s Berlin coalition partner, who are gearing up to oppose her in next autumn’s general election.

Kyriakopoulou says euro-scepticism across Europe will play a very important role in shaping the EU’s attitude towards the UK in the Brexit negotiations. “This is particularly the case in Germany and France, with the clouds of the Alternative for Germany (AfD) and the National Front hanging over the forthcoming elections in the two countries in 2017,” she says. And, the rise of euro-scepticism is probably going to strengthen Britain’s negotiating hand. Results of the local election in Germany show voters want EU reforms, including immigration curbs, adds Kyriakopoulou.

David March from OMFIF states that Merkel’s defeat provides Theresa May with a chance to warn European leaders that they will be dislodged by voter unrest unless they bring in reforms, including immigration curbs.

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February 8, 2016: If the oil price slumps, the stock prices plunge: Cheaper oil is clearly now regarded as negative, unlike in earlier times. We assess whether the economic correlations have really changed. Our analysis shows that a falling oil price is not always an economic stimulus programme for the USA and Europe. Fears that slumping oil prices could push the Western economies into a recession are exaggerated though.

The pure observation that the oil price has fallen sharply tells us very little. To assess the consequences of a lower oil price it essentially depends on why it has fallen. An analysis must therefore start at the supply and demand conditions.

Demand shock: If the global economy cools, global demand for crude oil falls and its price drops at a given production level. Under these conditions, the lower oil price is bad news. Amid falling sales expectations, businesses will cut investment even if their input costs fall due to lower energy prices. The smaller burden on companies and consumers because of the lower oil bill will at best dampen the shock to the economy.

Supply shock: If on the other hand oil producers significantly expand their production at unchanged demand, the price likewise falls. In this case however, a positive effect on consumer countries can be expected. Companies can expect higher margins and should increase their investment. In a smoothly running economy, consumers will generally spend their savings at the filling stations on other things rather than save, provided they view the oil price fall as lasting.

Consequently, the verdict of “oil down, economy up” is not categorically true, but rather the classic answer of economists that “it depends”. And even if it is clear what type of shock the oil price reflects, the forecaster faces two more difficulties:

Oil price rises and falls have an asymmetric impact: Rising oil prices are a direct blow to businesses and private households. These have no immediate alternatives and the rising energy bill therefore directly reduces their financial scope. How businesses and private households  use spare  funds, though, is  not clear.  If,  for example, consumers use the financial leeway from lower oil prices for higher savings and not additional consumption, the lower oil price would have only a slight positive impact on the economy.

Our calculations show that this tendency can be observed for Germany at least since 2010. So, we simulate the savings ratio based on private households’ expenditure on energy and their disposable income. Based on the actual savings ratio in Q1 2010, we assume that the savings ratio changes in subsequent years solely in that households save on all lower expenditure resulting from the oil price and finance all additional expenditure at a higher oil price through saving less. According to this calculation, the savings ratio of private households fell with the rising oil price between 2010 and 2013, while the savings ratio has risen again with falling oil prices since 2014.

Wait and see

The behaviour of private households and businesses depends strongly on their expectations of how sustainable they view the oil price slide. If consumers believe that the oil price slump is short lasting and oil prices will recover quickly, like in the financial and economic crisis in 2008/09, they are more likely to save this unexpected gain¹. If private households “learn” over time that the oil price will remain low on a lasting basis, they will change their behaviour and increase investment and consumption. In the USA, different reactions of consumers to oil price movements can be observed in the past decade. The second oil crisis of 1980 shows the clearest “classical” effect on consumption: consumers had to pay much more for fuel, real consumption slumped. As oil prices eased,  real  consumption  also  normalised  again.  In the further course of the 1980s a renewed oil price fall no longer had any impact on consumption and this generally continued up to the turn of the millennium. Consumers currently have to spend much less of their income at the service stations. Parallel to that, consumption has risen.

Producers are suffering a recession

For the industrial countries, a positive impact of an oil price slump can be established at most in the longer term, especially if the price fall is perceived as being lasting. On the other hand, the negative effect on oil producers is clearer. This is even visible in the USA, where corporate investment in oil production has almost halved in the last four quarters, which in purely arithmetic terms has lowered economic growth by half a percentage point. This strong reduction has been offset, however, by the rise in investment in other areas. In Q3 2015, investment in commercial construction and equipment came to 8.8% of GDP. The investment ratio has remained stable overall. In other words, this new theory that falling oil prices are clearly negative for the US economy cannot be proven either; the “recession” is limited to the oil sector.

The situation is worse in countries that mainly live from oil production, for instance the OPEC states or Russia. This even applies to the richest member of the “oil club”, Saudi Arabia. The economic output of the country, accounting for over an eighth of global oil production, depends on the oil price and reflects its movements. The rise of oil prices eased after the first oil price crisis in 1973, while oil prices fell from the mid-1980s. Parallel to this, real economic growth weakened considerably in the second half of the 1970s and the Saudi Arabian economy actually shrunk by up to 10% in the 1980s. Only with the recovery of oil prices after the turn of the millennium has Saudi Arabia’s economic growth recovered on a sustained basis. It is therefore indisputable that Saudi Arabia’s economy will come under noticeable pressure again in the latest oil price slide.

What applies to Saudi Arabia also holds true to other oil producing countries, which do not have as deep pockets as the Kingdom on the Persian Gulf. The Russian economy has not been able to reduce its dependency on oil any more than the OPEC states have.² The economic difficulties facing the country are also very apparent from the huge depreciation of the rouble in past months.

What are the consequences for the global economy?

OPEC and Russia are sales markets for German and US exporters. The importance of these markets should not be overestimated though, as they account for only 5% of the total exports of the USA and less than 6% of German exports. Even if US exports to these oil countries were to halve – a drastic and very unlikely scenario – this would be only 0.2% of US GDP, which would be within the bounds of normal estimation uncertainty.

From a holistic perspective, the importance of oil for the global economy has declined in any case. Before the first oil crisis in 1973, oil consumption of industrial countries rose in line with economic output. The following drastic rise in the price of oil triggered substantial improvements in efficiency and the restructuring of economies. Consequently, oil consumption and economic output have decoupled themselves since 1980. By way of example, oil consumption and real GDP in the US both rose by 220% between 1949 and 1979, while between 1980 and 2014 oil consumption increased by only 12% and GDP by almost 150%. A similar picture can be seen for Germany and the rest of the world.

Financial market risks of US fracking industry are limited

The real economy may therefore be better protected from oil shocks than in the past. But what about the financial markets? Indeed, oil has become an important asset class. One type of “oil assets” is the bonds US shale oil firms issued to finance their rapid. Could a financial collapse of this sector like in 2007 trigger a global financial and economic crisis? After all, some 15% of high-interest bonds (“Junk Bonds”) are in the energy sector. However, compared to the total market for corporate bonds, the volumes of this asset class are relatively low.

Turning to equities, in the S&P-500, energy stocks have a weighting of 6.4% and large and capital-strong companies dominate, not start-up oil “frackers”. Regarding assets under management by investment funds, stocks from the energy sector comprise only 1¼% of the total stocks under management. Of the bonds managed by investment funds, the share from the energy sector is less than 3%.

There is still a certain residual risk though; presumably no financial shocks can trigger a herd instinct, precisely when investors react sensitively in a fragile global economic environment like the current one. This applies all the more when individual banks with strong involvement in the oil sector slide into difficulties.

In short, if there’s a fire, then not at the oil well

The global economy will hardly slip up on oil. The attention currently being paid to the oil price can therefore only be attributed to its function as a weathervane. The slump of oil prices might indicate global economic problems that have not yet been reflected in the usual economic data. This would make the oil price merely a symptom of the crisis; the actual cause would lie elsewhere.

To be noted:

[1] In other words, their expectation of permanent income has not changed.

[2] In the case of Russia, the consequences of the Crimean crisis have also harmed the economy, although the slump in oil prices was probably much more painful than all Western sanctions.

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