punitive tariffs

Germany's dangerous Chinese addiction

Views Of Chinese Yuan As Yuan Crunch Spurs Banks to Hoard Abroad as China Curbs Outflows
Make it rain! Source: Bloomberg

For his first public speech as CEO, German carmaker Volkswagen sent Herbert Diess to the Beijing Auto Show, underlining the country’s importance for the world’s biggest carmaker. VW sold 4.2 million vehicles there last year, more than one in three, and intends to invest a further €15 billion ($18 billion) in its largest sales and growth market by 2022. The country is so important, Mr. Diess even ended his speech in the local tongue: “Xie Xie,” he said. Thank you.

Car executives aren’t the only German higher-ups grateful to be in China. The country is the third-most important importer of German goods behind the US and France and a main market for many German companies – and the most important source of growth. No other western nation is as closely interwoven with China as Germany. German companies generate an average of about 7 percent of their sales in China and the 30 companies on the benchmark DAX index alone have nearly 700 subsidiaries there. According to Handelsblatt calculations, those subsidiaries generated 15 percent of their parent’s sales last year, or almost €200 billion, a record.

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A lot less would be “Made in Germany” without China. BMW, Daimler and VW as well as the specialty chemicals group Covestro get more than 20 percent of their euros there and China is their biggest market, even more important than Germany. Even the once-struggling Munich semiconductor maker Infineon generates 25 percent of its sales in the world’s most populous country. Should Chinese growth slow, because of a trade war with the US or an over-dependence on credit, Germany will suffer disproportionately.

“Particularly Germany has a problem if the American-Chinese conflict actually worsens,” warns Dennis Snower, President of the Kiel Institute for the World Economy. The spiderweb of international trade could even punish Germany doubly or triply: Many companies not only sell to the US but also manufacture there before exporting to China. Next year, Daimler and BMW alone are expected to send more than 100,000 vehicles to China from the US, subjecting them to punitive Chinese tariffs as well. Since the vehicles are predominantly premium models, that could cost them up to €1.4 billion.

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In the worst case, the effects of a trade war could be linked to the other factor currently threatening growth in China: The debt of private households, companies and the public sector in China has increased dramatically to $31 trillion. That’s 257 percent of China’s gross domestic product and twice what it was a decade ago. “Should the government’s efforts to curb credit growth lead to a more pronounced slowdown in growth than currently assumed, this would result in a noticeable slowdown in the global economy,” warns Daimler in its annual report.

The 30 DAX companies earned over €90 billion in profits last year worldwide and Bayer, BMW, Daimler and 10 other members achieved the highest profit in their corporate history. Analysts expect another 10 percent increase this year to nearly €100 billion. If there is anything that could abruptly dash these, it is quitting the Chinese drug cold turkey. Economic history suggests that this withdrawal will come. So far, no economy has managed to grow from an emerging country to an industrial nation without crises and setbacks.

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Is China now also being hit with similar growth pains? And will a trade war trigger this crisis? China is less dependent on exports today than just a few years ago. A huge middle class is emerging, whose consumer demand is increasingly driving the economy and making the economy less dependent on exports.

China exported $506 billion in goods to the US last year and its economy is expected to grow by 6.6 percent in 2018 according to the IMF. The tariffs would reduce that figure by half a percentage point. An escalation coupled with the high debt could make things worse. “The financial problems in China are serious,” says David Dollar from the Brookings think tank, who also once headed up the World Bank’s Chinese office.

The signs that the German economy will not survive the conflict unscathed are growing stronger and it got off to a weak start this year. In February, German exports fell by 3.2 percent compared to the previous month. The trade union-oriented IMK economic research institute is alarmed and, for April to the end of June, its early warning instrument, which bundles current data on the economic situation, shows an average probability of a recession of 32.4 percent. In March, the figure was 6.8 percent.

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Companies cannot change much about these risks. “We have to make decisions on the construction of plants such as those in Spartanburg or Mexico with a horizon of 20 to 30 years,” explained BMW Board Member Peter Schwarzenbauer. However, minor adjustments are possible. For example, the SUV X3 will no longer be exported from Spartanburg to China. Instead, BMW wants to ramp up production in China — and thus avoid customs duties between the two major economies.

This is a good move to avoid the direct effects of customs duties. But such evasive maneuvers are of little use in a major trade war that could pull down the economy in China and possibly also in the US. Germany might then have to look elsewhere for growth.

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Markus Fasse specializes in aviation and automobile industry news and works from Munich. Martin-Werner Buchenau reports from Stuttgart as Baden-Württemberg correspondent. Bert-Friedrich Fröndhoff leads a team of reporters which covers the chemicals, healthcare and services industries. Joachim Hofer is a Handelsblatt correspondent in Munich. Sha Hua is a correspondent for Handelsblatt in Beijing. Thomas Jahn is a Handelsblatt correspondent in New York. Ulf Sommer reports for Handelsblatt on companies and financial markets. To contact the authors: sommer@handelsblatt.com, fasse@handelsblatt.com,  buchenau@handelsblatt.comfroendhoff@handelsblatt.comhofer@handelsblatt.com, hua@handelsblatt.com, jahn@handelsblatt.com

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