Energy Crisis Fallout: How Bad Will the German Recession Be? - DER SPIEGEL

2022-09-17 01:47:17 By : Mr. Henry Tan

Production at Volkswagen: Potential new car buyers are holding back on recession worries.

To get a better idea of what lies ahead for the German economy, you can go out and talk to executives in the automotive industry and scholars of the economy; you can study inflation data and share prices. But it's probably also enough just to take a look at an indispensable, everyday product: toilet paper.

In the early days of the coronavirus pandemic, the product served as a gauge of the level of Germans' anxiety. The steeper the rate of infection, the emptier the shelves. Manufacturers of the hygiene product were even among the beneficiaries of the pandemic. Now, worries are once again growing across the country about potential shortages of toilet paper, only this time for completely different reasons. Hakle, a household brand name in Germany founded almost 100 years ago, last week filed for bankruptcy in self-administration.

The medium-sized paper manufacturer is one of the first victims of the crisis that is eating through the entire country. You need energy to turn wood into toilet paper – quite a lot of it. Hakle uses 60,000 megawatt hours of natural gas and 40,000 megawatt hours of electricity annually at its Düsseldorf plant alone. And the company can no longer afford it. Skyrocketing energy and raw material prices combined to push Hakle over the edge.

And they're not alone. Bad news from companies all over the country is piling up.

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Company CEOs and union leaders are now speaking openly about their fears. "The worst is yet to come," says CEO Klaus-Dieter Maubach of the German natural gas import giant Uniper, referring to energy prices. And Yasmin Fahimi, head of the powerful DGB union, warned in an interview with DER SPIEGEL that if the government doesn't take swift countermeasures, there is a risk of domino effect that could lead to the de-industrialization of Germany. "That would be a disaster."

The question is no longer whether the crisis will come. The question is how bad it will be and how long it will last.

This tragedy has five acts, and it begins with the energy price shock. Its first victims have been manufacturers that are highly dependent on electricity and gas: paper manufacturers, fertilizer producers, steelmakers. They pass on the price increases – the second act – to other sectors, from industrial companies to small and medium-sized enterprises. For many companies, it is now a matter of sheer survival: More than 90 percent of companies see the increased prices for energy and raw materials as a strong or even existential challenge, according to a recent survey conducted by the Federation of German Industries (BDI).

Companies usually have no choice but to pass on the price increases to consumers, who are already having to save money to cover their skyrocketing electricity and gas bills. And that raises the curtain on the third act, the one with the makings of an economic disaster: Consumer sentiment is worse than it has ever been in postwar German history.

Vacation? A dinner out? New furniture? "These are purchases that millions of people in Germany will now postpone," warns economic researcher Sebastian Dullien, director of the trade union-affiliated Macroeconomic Policy Institute (IMK). Skyrocketing energy prices, he says, are a "gigantic macroeconomic shock." Some households don't know how they are going to pay the next heating bill, the economist warns. If the heater even works at all – a certainty is beginning to waiver in the face of looming shortages  .

Consumption goes down, the first companies throw in the towel and, at some point, unemployment rises. Welcome to acts four and five of the economic drama. There is a word for this horror scenario that awakens age-old fears: recession. And it looks like the country will soon be right in the middle of one.

In the second quarter of 2022, the German economy grew by a paltry 0.1 percent. Economic researchers and policymakers alike are convinced that the next quarterly numbers will be negative. The question is whether politicians will manage to mitigate the consequences – or if there is a threat of an economic crisis that may last for several years with "losses of prosperity on a previously unimaginable scale," as Peter Adrian, the president of the Association of German Chambers of Commerce and Industry (DIHK) put it. In other words, a crisis that could eat away at the country's substance, undermining social security funds and the state's ability to act. It could also lead to the permanent disappearance of many companies. A crisis that would make Germans poorer.

These days, it's difficult to tell where to draw the line between pessimism and justified panic. What is certain is that Putin's economic war is hitting Germany where it hurts most: a gas price that has already more than quadrupled is crushing competitiveness, across pretty much all industries.

The current gas crisis has all the "ingredients for this to be the energy industry's Lehman Brothers," Finnish Economic Affairs Minister Mike Lintilä said recently. Back in 2008, investment banks triggered a global financial and economic crisis by selling toxic home mortgages tied up in wild securities constructs. This time, it is high gas and electricity prices that could trigger a systemic collapse.

Alexander Becker is desperate. "We really don't know what to do anymore," says the CEO of the Georgsmarienhütte Group (GMH). "We're in a state of shock."

The company is one of Germany's larger steel producers. With 21 facilities, 6,000 employees, its own foundries and forgers – and a power requirement of 1 terawatt hour of electricity a year. That's more than the electricity consumption of 300,000 single-family homes.

Last year, the company paid 120 million euros for electricity and gas. If prices remain at current levels, costs will rocket to 1.2 billion euros next year. At worst, a loss of 1 billion euros would be incurred in the coming year. "We would be bankrupt immediately," Becker says.

To avoid that, GMH would have to raise its steel prices by 50 percent. "Customers won't go along with that," Becker says. Even the 20 percent boost in prices that have already been applied can't be implemented at two locations because customers have long since started buying their steel from China and India, where energy costs have so far risen only moderately, if at all. Becker has even instructed his own forges, which normally process domestic steel, to buy cheaper in Asia, a move that is particularly painful for him. "If policymakers don't take action quickly, Germany's energy-intensive industrial companies won't survive," Becker warns. Nonetheless, his plant is still operating.

Alexander Becker, managing director of the Georgsmarienhütte Group

Rival Arcelor Mittal, on the other hand, has given up for the time being. The company recently announced that it would be shutting down two production facilities indefinitely in Hamburg and Bremen due to the "exorbitant rise in energy prices." This had been compounded by weak market demand and a negative economic outlook. The company said it was no longer economically viable to operate all of its plants.

The coronavirus pandemic showed how easily modern production processes can get out of sync. Supply chains interlock like the insides of a clock, and if one cog fails, the entire machinery can grind to a halt.

An example is a small company from Lutherstadt Wittenberg, Germany, which has made it onto the prime-time news broadcasts in recent days because its products are needed almost everywhere. "Our production has been halted completely," says Torsten Klett, the co-managing director of SKW Stickstoffwerke Piesteritz. "And we will only be able to restart if the gas price drops significantly or if politicians provide us with massive support." The chemical company is one of Germany's largest producers of fertilizers and AdBlue. Natural gas has also become too expensive for SKW. If political help doesn't arrive soon, the company could be forced to send its 860 employees into a work furlough program in October.

Few modern diesel engines can be operated without AdBlue – not those of the fire department, not those used in public transportation and, above all, not the 800,000 or so trucks that transport goods of all kinds across Germany's roads every day. Should companies no longer receive the products they need for their own production, the result wold be devastating, and almost all sectors would be affected.

The national association representing the logistics industry has begun warning of potential bottlenecks, even though AdBlue is also manufactured by BASF and the Norwegian firm Yara. But BASF began cutting back on ammonia production last year due to increased gas prices. The world's largest chemical company can still compensate for the shortfall by buying on the world market, though the costs continue to rise.

The willingness and ability of chemical industry customers to pay the higher prices now being demanded is rapidly shrinking, says Wolfgang Grosse Entrup, chief executive of the German Chemical Industry Association (VCI). Because the outlook for economic development is growing increasingly gloomy, construction projects are being postponed, people are holding off on buying new cars and they're fixing old washing machines rather than buying new ones.

Gunnar Kilian, Volkswagen's chief human resources officer, has actually grown used to states of emergency. Since the spring of 2020, the crisis teams at Germany's largest carmaker have been meeting pretty much on a weekly basis, just that the focus of those meetings has been shifting constantly. First, it was the coronavirus, then microchip shortages, then the Ukraine war and now its skyrocketing energy crisis. Around 20 specialists monitor issues such as the plants' energy requirements and also discuss with employee representatives on the works council how low they can set the room temperature in the factory halls to save on gas.

"We have become more crisis-resistant over the years," says Kilian. He says there is still a need for personnel in fields of the future like software and batteries and that the order books are full. The fact that the company is having trouble keeping up with production is primarily due to the shortage of raw materials and car parts. Customers sometimes have to wait a year for a new Golf. Indeed, full order books aren't helpful if the goods can't be produced, a phenomenon known as excess demand.

That, though, could quickly turn into a demand crisis. "High energy prices and the emerging recession are making new car buyers more reluctant to buy," says Ferdinand Dudenhöffer, director of Center Automotive Research. And if customers then also have to reckon with fewer discounts and higher financing costs, "the car market will fall into a recession along with the economy as a whole."

Last week, the German Association of the Automotive Industry (VDA) dramatically corrected its market forecast for Germany from the previous 3 percent growth to negative 6 percent. "Our economic model is in question," warns VDA President Hildegard Müller. Two out of five companies in Germany are unable to pass on the high energy costs to their customers, she says.

Hakle CEO Volker Jung: "The question will be whether we can still afford paper production in Germany at all."

That, too, has triggered a chain reaction. The deeper the automotive and chemical sectors slide into crisis, the less they invest in new machinery. Lobbyists for the association have begun reporting that companies are postponing planned investments in more climate-friendly production facilities. "At the same time, we need these investments in renewable energies, in the hydrogen economy and in the electricity infrastructure to solve the problems we have," says Karl Haeusgen, president of the German Engineering Federation (VDMA).

Even in booming sectors like the construction industry, which contributes more than 6 percent to Germany's gross domestic product, the mood is currently tipping. In June, new orders fell by 11.2 percent relative to the same period last year. According to Tim-Oliver Müller, CEO of the German Construction Federation, the sector is still running at full capacity and completing existing construction projects. But more and more project developers are having to postpone or even cancel new construction projects due to skyrocketing costs. Residential construction has been hit particularly hard.

Jens Rautenberg, the managing director of the analyst firm Conversio Wahre Werte, estimates that around 40 percent of all new residential construction projects have currently been halted. Major institutional investors like insurance companies and pension funds have stopped buying real estate because of the sharp rise in interest rates. Private demand to buy homes has also collapsed "even to zero in some places."

Project developers who don't have sufficient capital buffers won't last long. Only recently, the crisis hit the Berlin-based company Terragon, which specializes in expensive senior housing. The company could no longer cope with the massive increase in construction costs. After eating through its capital, it is now looking for a new investor.

The Germans aren't just saving on major projects like building a new home, they are also cutting back purchases in their everyday lives. With food prices also through the roof, many families have also been forced to calculate more carefully when shopping at the supermarket. No matter where you ask – electronics retailers, fashion chains or furniture sellers – resignation is everywhere. "People are simply afraid," says the owner of a large furniture chain. "I would like to skip a lot of discount sales and just sit out the crisis. But if I do that, no one will come at all."

It's a fear shared by many of his colleagues at the moment. So, they are instead ramping up their marketing budgets – hoping that if their products are just cheap enough, people will buy. The main thing is that they clear out the warehouses this winter. "Everyone in the industry is having problems with overstocks," says Carlo Focke, who owns Modehaus Bruns, a small department store in the town of Neuruppin. "It all has to go."

Healthy companies may be able to handle such promotions for a few weeks. But companies already suffering from financial difficulties, like the major department store chain Galeria Karstadt Kaufhof (GKK), are expecting a very tough winter. They simply can no longer afford discount battles. The company, which has already gone through insolvency and is being propped up by the government to the tune of 700 million euros, is seeing its reserves melt away.

The next few weeks could determine the chain's fate, one insider says. Energy costs at some stores have increased ten-fold in recent months, merchandise costs more to buy, and customers are shying away. "If the Christmas business goes as planned, then we have eight or nine months of breathing room." And if it doesn't, his message is clear, things will be tough.

And the outlook isn't good. The "Germany City Center Study" compiled by the consulting firm CIMA is projecting a "net loss of visitors" of 20 percent across all age groups, with the affluent classes, in particular, likely to stay at home. This would hit retailers hard.

Instead of going into the city and shopping, many Germans saved their money at banks during the coronavirus pandemic. But those savings are also declining, with high inflation eating them up. Thus, "private consumption will probably fail to act as an economic engine in Germany for the rest of the year," warn the experts at the Ifo Institute, a respected economic think tank.

Many companies are unlikely to survive. In August alone, the number of insolvencies among corporations and partnerships, mostly medium-sized firms, grew by a quarter year-on-year. For October, Steffen Müller of the Leibniz Institute for Economic Research in Halle predicts an increase of one-third compared to 2021. And this doesn't even take into account the increased energy costs and inflation. Müller expects a structural change in the German economy. Due to the long-term cost increases in energy, wages, intermediate products and interest rates on loans, "some business models are just no longer sustainable." Müller says that weak companies "are now getting flushed out of the market."

What concerns him is the nature of corporate bankruptcies. Whereas the pandemic mainly hit the services industry, the current crisis is now hitting the country's industrial core. Forty percent of the jobs affected in the larger insolvencies are industry jobs, Müller says, meaning mostly above-average pay, combined with higher payroll taxes for the government and higher purchasing power for retailers.

The German government is trying to prevent a wave of bankruptcies by relaxing insolvency rules. Speaking to the federal parliament, the Bundestag, Economy Minister Robert Habeck of the Green Party promised a "broad rescue package" that would also provide relief for small and medium-sized enterprises. "We will protect German companies," he told lawmakers on Thursday as he presented his budget.

Stefan Kooths, vice president of IfW Kiel

But rescue packages and hastily cobbled together relief measures serve at most to ease the pain. "We can't muddle through the energy crisis with aid packages," warns Stefan Kooths, vice president of the respected IfW Kiel economic think tank. He says Germany needs a "strategic reorientation" of its energy policy. "Do we rely on LNG in the long term? Do we allow fracking? Do we re-evaluate nuclear power?" He says companies will only know what energy prices they can expect in the future once those fundamental decisions have been made. "Then you can put together targeted relief packages to soften the blow," Kooths says.

The institute still expects economic growth of 1.4 percent for this year. But next year, it expects gross domestic product to shrink by 0.7 percent. At first, that may sound trivial, but not if you compare it with the upswing that economists had firmly planned for after the coronavirus crisis. "We had to adjust our forecast downward by four percentage points," Kooths says. "Instead of the hoped-for economic recovery, Germany will experience a painful recession."

Fears of losing one's job have been hard-wired in the minds of Germans for decades – no one wants to go back to the 2000s, when up to 5 million people in Germany were looking for a job.

Today, the situation is paradoxical. While some companies are still desperately looking for skilled workers, others have announced they would be sending employees into work furlough programs, called short-time work in Germany. Under the government-backed programs, working hours are reduced and the government pays part of the workers' salary shortfalls. The fact that recession and labor shortages are about to occur at the same time is an unusual situation, says Enzo Weber of the Nuremberg-based Institute for Employment Research (IAB). "We have never had such a shortage of labor in decades. At the moment, there are 2 million vacancies, and people are still desperately needed in virtually all sectors." As such, many companies are therefore determined to retain their employees even during the crisis, Weber argues. This could drive up the number of people on short-time work but prevent mass layoffs.

The only question is how much short-time work the country can still afford. The coffers of the Federal Labor Office, which administers the program, are empty. During the pandemic, the state spent 40 billion euros on short-time work. The employment agencies across Germany have long been in crisis mode. Experts there are now asking whether short-time work is still the panacea for a crisis that is getting out of hand – or whether insolvency aid and completely new measures are more likely to be needed in the future.

Hakle CEO Volker Jung wants to save 200 or so jobs at the toilet paper company, and production will continue for the time being. But without help from the government, he sees little chance. "The question will be whether we can still afford paper production in Germany at all," he says, before calling for the government to introduce an energy price cap.

Will that be enough? It's true that the company's history is full of records: the first three-ply toilet paper, the first moist toilet paper and then even four-ply paper.

On the other hand, Hakle has only generated profits twice in the past 10 years, the last one during the toilet paper boom sparked by the pandemic. Customers were hoarding everything at the time, including expensive brands like Hakle.

But in an era of shrinking disposable incomes, Germans are once again mainly reaching for cheaper labels and getting by with two layers. Consumers, it seems, are cutting back wherever they can.

Production at Volkswagen: Potential new car buyers are holding back on recession worries.

Hakle CEO Volker Jung: "The question will be whether we can still afford paper production in Germany at all."