Germany Is Barreling Headlong Into A Painful Inflation Trap

There is nothing more “anti-social” than inflation

By Wolf Richter

It was a blatant act of fear mongering just before the EU Summit: if Greece were allowed to default and exit the Eurozone, it could trigger the exits of Portugal, Spain, and Italy, which, in a worst-case scenario, could cost the world economy €17.2 trillion in economic growth.

“Hence it is incumbent upon the community of nations to prevent Greece from a sovereign default as well as leaving the euro, and the domino effect that this event could induce,” the study urged.

The study was commissioned by the politically powerful Bertlesmann Foundation, which owns 77.6% of Bertlesmann SE & Co., a multinational media company based in Germany. The foundation is known for its agenda—now including the doctrine that taxpayers must always bail out certain bondholders in order to prop up confidence in the financial markets.

“Insolvency procrastination” is how a quintessential German industrialist responded. And if after Greece’s exit, the whole Eurozone dissolved? “To throw good money after bad is something that normally only over-indebted businesspeople do,” he said. “It’s irresponsible.”

Tough words for the EU Summit crowd. Heinrich Weiss, Chairman and CEO of SMS Holding GmbH, didn’t mince words as he laid out his euro pessimism in an interview with Manager Magazin.

SMS is, in a sense, a microcosm of the German export economy. The family-owned company has about 10,500 employees. Its subsidiaries excel in mechanical engineering, machine tools, and plant construction for processing steel, aluminum, and nonferrous metals. Some of the items it manufactures are so heavy that getting them to the port can be a headache, given Germany’s aging bridges and infrastructure constraints. And it exports: 57% of its orders came from Asia, 28% from Europe and Russia, 14% from the US, and 1% from Africa.

During the financial crisis, its order intake collapsed by 55%, from €5.3 billion in 2008 to €2.3 billion in 2009. Then orders recovered, reaching €3.4 billion in 2011 (annual report). During bad times, the company lives off its order backlog. It was €6.3 billion in 2008. In 2009, SMS ate up 26% of its order backlog, and in 2010 reduced it further to €4.5 billion. In 2011, it recovered a bit. Due to the order cushion in 2008, sales actually increased during the worst part of the financial crisis, from €3.6 billion in 2008 to €3.9 billion in 2009—but then, the order drop-off caused sales to plummet to just over €3 billion in 2010 and 2011.

The business is cyclical, with ups and downs every two or three years, Weiss explained. After the few good years recently, a downturn would be expected. “But I’m afraid that this one will be deeper and longer than we have become used to,” he said.

Since over 80% of the company’s revenues came from outside the Eurozone, he expected that SMS would be able to ride out the debt crisis unscathed. But over the summer, their customers worldwide became “more reticent”—and postponed projects. The debt crisis had begun to impact the rest of the world [also read.... The Noose Tightens On Germany’s “Success Recipe”].

The bond-buying program by the ECB and the establishment of the ESM bailout fund may have calmed the waters, but “as citizen and family entrepreneur,” he was convinced the calm would be temporary, and things would get worse. Why? The “inflation trap,” he said, there being nothing more “anti-social” than inflation.

Consumers would be in a tough spot. Due to the existing “Transfer Union,” it’s “certain today that the standard of living in Germany cannot be maintained.” When citizens feel the loss of wealth due to these transfers to Germany’s neighbors and due to rising inflation, domestic demand for consumer goods would “shrivel over the medium term.” But stimulus programs with borrowed money would be “the last thing we can afford,” he said, calling it a “scandal” that Germany hasn’t been able to reduce its debt despite “record tax revenues.”

To get through the crisis, SMS would do three things, he said: remain “at the top of its sector,” maintain a financially conservative approach to be able to live off its reserves, and.... “prepare for inflation.” His strategy: invest a big part of their free liquidity “in industrial substance.” All inflationary times have proven that those who invested in substance, for example in well-run companies, had “fewer losses,” he said. So they’re looking for acquisitions.

And the next 12 months? SMS was currently using overtime to keep up, he said, but with orders for 2012 dropping to €3 billion, capacity utilization will fade, and the company might have to shift to part-time work (Kurzarbeit) next year. He couldn’t give a forecast; the situation was “too uncertain,” he said, but for 2013, “we’re pessimistic.”

Two thermometers into corporate brains plunged to depth not seen since the trough of the financial crisis when the US was losing hundreds of thousands of jobs a month. One was based on responses from CEOs of America’s largest corporations; the other was based on responses from analysts and their industry contacts. Just before Lehman, these people had exactly zero predictive capabilities. So, could they now have ulterior motives? Read....  Fear of Impending Economic Collapse Or Just Manipulation?