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A weaker German economy could further slow Europe

Friday - 6/29/2012, 3:27am  ET

By DAVID McHUGH and CHRISTOPHER S. RUGABER
AP Business Writers

FRANKFURT, Germany (AP) - For Germany, the crisis gripping Europe can feel like someone else's problem. Its economy is growing. Unemployment is low. And its government can borrow at lower interest rates than any other country in the euro alliance.

That helps explain why Chancellor Angela Merkel seems to favor a slower approach to the financial crisis than other leaders do _ especially if a solution would impose a heavy burden on Germans.

But now, Germany itself is at risk of a slowdown, which would make it even harder to end Europe's crisis. Many analysts say a downturn would hit home to Germans how much they depend on the health of other European economies. If so, they could become more willing to put money at risk to support their weaker neighbors.

Such issues are helping drive talks that continued early Friday at a European Union summit in Brussels. Italy and Spain pressed leaders of the 17 countries that use the euro to seek ways to ease their borrowing costs. And a modest deal by the 27 leaders of the EU to stimulate growth was thrown into flux after Italy and Spain said they'd block it unless it was paired with immediate steps to help lower interest rates on their government bonds.

Germany is the biggest country in the eurozone. Concerns about its economy grew last week with a report that German business optimism fell in June. Earlier in the week, a survey showed manufacturing was slowing. Germany's economy is powered by exports, and manufacturing is at the heart.

Both surveys are intended to forecast where Germany's economy could be in several months. For now, its economy remains far stronger than its European neighbors'.

Unemployment is just 5.4 percent. German autos and other products have been selling well in China and North America. Low interest rates have made it easy to borrow and invest. And the euro's value, held down by weaker nations in the currency alliance, has made German goods affordable for foreign buyers.

But Europe's raging debt crisis threatens the entire continent. Nearly 60 percent of Germany's exports go to the 27 countries in the EU. Recessions in Greece, Spain, Italy and Portugal are weakening demand for those goods.

Slowing growth by its trading partners in Asia is also affecting Germany's economy. Asia accounted for 16 percent of German exports. Germany's exports to China surged 15 percent last year and contributed significantly to Germany's 3 percent growth in 2011.

Fear of a catastrophe, possibly resulting from a Greek exit from the eurozone or the need to bail out a big economy like Italy's, could make German businesses scale back plans to expand.

Economists still foresee modest growth in Germany this year, whose gross domestic product totaled (EURO)2.57 trillion ($3.42 trillion) in 2011 and accounted for 27 percent of the eurozone's economy. The interest rate on Germany's 10-year bond is just 1.56 percent _ even lower than the rate on the U.S. 10-year Treasury note.

But the risks of a downturn are growing. The government predicts 0.7 percent growth this year. Other forecasts range from 0.5 to 1.0 percent.

Perhaps the biggest issue is how a recession in Germany would affect its willingness to put its stellar credit rating behind weaker countries so they could borrow affordably.

Germany has resisted proposals for so-called eurobonds. These would be bonds issued jointly by all 17 countries in the eurozone. Because they'd be backed by the collective power of so many countries, including Germany, they'd carry a low interest rate. But eurobonds would put Germany partly on the hook if a big country like Spain or Italy defaulted.

Another idea would be to take the excessive debts of eurozone countries and put them into a "debt redemption fund." The fund would be jointly guaranteed and could be paid down over two decades or more.

If Germans began to fear for their jobs, would their resistance to these proposals begin to melt?

Many analysts suggest it would. They think a downturn would force more Germans to recognize how much they depend on other European nations to buy their goods and support the German economy. They could become more willing to jointly accept the risks of backing weaker countries' debts.

"The main constraint here is political _ the willingness to help, rather than the ability," said Randall Henning, a professor of international economic policy at American University in Washington.

Douglas Elliott, a fellow in economic studies at the Brookings Institution in Washington, said he thinks Germany could turn more sympathetic to its neighbors as their economic problems cut into Germany's exports.

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