China’s Relationship with Germany and the High Euro

This past year has seeing the US dollar and the US economy growing steadily after years of anemic progress following the 2009 global recession. Economies like China and Brazil, once the stable economic engines surviving the recession with a few scratches, are now the likely source of a new global economic downturn. The reliability of Chinese economic data has not been stellar, and nervous investors have fled the Chinese market this past month due to fears of a greater crash in the Chinese economy. Emerging markets that depended on Chinese growth in order to profit from raw material exports have been struggling. Economic mismanagement and a dwindling source of revenue coming from exports to China has left Brazil in a perilous economic situation—a situation they assumed was in the past and would stay in the history books.

The shrinking demand in China has affected natural resource economies in different ways. Low oil prices have hit emerging markets hard, and have even dented some otherwise healthy and diverse economies. Canada, an example of a diversified economy based on manufacturing and energy, has been able to weather a low oil price by ramping up manufacturing. With the drop in oil prices and other natural resources due to the slowdown in China, the Canadian dollar has fallen, making Canadian manufactured good less expensive on the global market. While Canada’s manufacturing regions face additional challenges, the low Canadian dollar acts as a cushion to a drop in commodity prices by boosting demand for Canadian goods.

Germany has benefited the most from previous double digit growth in China. Demand in China for high-end German manufactured goods, especially in the automotive sector, has driven much of Germany’s impressive growth over the last few years. Engineering and high-end German products helped build much of China’s transport and infrastructure during its boom. With a slowdown in Chinese growth, Germany’s source of wealthy consumers may be greatly restricted. While Canada offsets its energy sector losses with an increase in manufacturing and exports thanks to a low currency value, the slowdown in China has created a situation where funds leaving China have gone into euros. With investors seeking a safe haven for their funds, the value of the euro was up greatly compared to other world currencies this month. A slowdown in demand for German products and a high euro is creating a barrier to purchasing European goods and services for those outside the region. Even with a high US dollar, the boost in the value of the euro will deter Germany’s other large export market, the United States, from buying its products.

The slowdown in China may not be as severe as many expect, but it is unlikely that demand for German high-end products and engineering services will rebound in China for the next few months. The value of the euro may respond to Germany’s economic slowdown, but if investors keep the euro high, it will be a difficult time to purchase European goods for the rest of us. Expect the European Central Bank to address this challenge if the Euro remains high and demand does not return to a healthy level. In the end, it will really depend on China and whether investors trust the economic data coming out from the government and cushion losses in China by returning to the yuan.