Why You Should Invest in the "New" Germany

Pundits greeted Angela Merkel's convincing election win in Germany Sunday with a collective yawn. Commentators think the German economy is sluggish and over-dependent on exports, and believe that a change in the German government from a grand coalition to a center-right coalition will make little policy difference.

I think that's wrong. It's an erroneous viewpoint that's symptomatic of the short memories of the chattering media. It's also one that could cause investors to miss out on one of the best profit plays in the global marketplace today.

I'm talking about Germany – the real powerhouse of Europe.

The "New" Germany

From the 1950s to the 1980s, West Germany consistently delivered high growth rates and low inflation. West German engineering proved superior to any other on the planet. And West German living standards rose far above anywhere else in Europe.

Then came 1990.

East and West Germany were reunited and an economic malaise set in. Instead of unifying the two currencies at a ratio of two Ostmarks to one Deutsche Mark, which would have kept East German labor cheap and competitive, the politicians unified the currencies at a rate of one to one.

That meant that East German labor was instantly priced out of the world market. And with good reason: It now offered Soviet-sector efficiency and skill – but at West German costs levels. Consequently, East Germany went through more than a decade of very high unemployment. German taxpayers went through more than a decade of huge subsidies to the former East Germany to prop up that region's living standards and retrain its labor.

However, since the excellent German high school education system was quickly established throughout the country, the burden of reunification was a problem that did not last forever. What ultimately happened was that younger, fully trained workers in East Germany replaced their inferior Communist-era parents.

From about 2005 onward, the financial cloud of reunification costs began to lift. During the last few years, Germany's economic performance has been notably better than its European competitors. Against Italy alone, for example, Germany's competitiveness has improved by more than 20% since Europe's currencies were unified in 1999.

The German economy has been held down by a tax burden that's high by global standards. Its tax system suffers from excessive complexity and from draconian enforcement. Small businesses, for example must pay a 14% trade tax – on top of the standard corporate income tax that all businesses must pay. The trade tax goes to the "lander" (the states), rather than to the federal government.

Despite such problems, Germany has played it smart in several key areas. Unlike the United States and many other countries, Germany did not engage in fiscal stimulus. Indeed, the Social Democrat Finance Minister Peer Steinbruck last winter referred to Britain's huge fiscal stimulus plans as "crass Keynesianism." That showed that Germany has a true consensus against the stimulus foolishness. Germany's budget deficit is expected by The Economist panel of forecasters to be only 4.6% of gross domestic product (GDP) in 2009, far below its rich-country competitors. Thus, even though Germany's taxes are high, they will not be forced further upwards by zooming budget deficits.

The Angela Merkel Era Begins

Merkel's election as German Chancellor is important, because it enables her to govern in coalition with the most free-market party, the Free Democrats, who are committed to lowering taxes and freeing up some of Germany's restrictive labor laws.

This should not be taken too far. The Free Democrat leader Guido Westerwelle, flushed with victory, pledged Sunday night that the new government would act "responsibly" – not exactly "Hope and Change" as a slogan! Nevertheless, the Frankfurt market rose on the election result, as it should have done.

Germany is sometimes knocked for its export orientation. Its balance-of-payments surplus was $179.4 billion for the fiscal year that ended June 30, and is expected to be 4.0% of GDP this year.

Rest assured, however, that this is strength, and not a weakness. With world trade recovering, the German economy can be expected to benefit. Just look at Germany's auto sector, which may be the most well rounded in the world. It boasts such strong luxury brands as Mercedes (NYSE ADR: DAI), Porsche and Audi. And it includes such high-volume – but innovative – manufacturers as Volkswagen AG (OTC ADR: VLKAY). German automakers are likely to gain market share against faltering U.S. competitors in the coming global recovery.

Another plus: Germany's savings rate rose to 12.8% of GDP in the first half of 2009, a 16-year record. That compares with the feeble rate of only 4% in the United States, up from close to zero in the preceding three years. In a competitive world with the financial sector in difficulty, it's better to be a capital-rich country running a trade surplus than the opposite, like the United States.

The economic recovery is a mixed bag from one market to another. But in Germany, it seems in Germany to be proceeding briskly. GDP, which fell sharply in the first quarter, rose at a 1.3% annual rate in the second quarter. Manufacturing orders rose by 3.5% in July, after a 3.8% rise in June. The ZEW index of economic sentiment has risen in each of the last six months, reaching a healthy 57.7 (50 is neutral) in September.

With competitive manufacturing, a business-friendly government and plenty of domestic capital, Germany is about as healthy an economy as there is in the world today. You should think about staking a claim to this outlook, even if it's only the MSCI Germany Exchange-Traded Fund (NYSE: EWG).

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News and Related Story Links:

• Money Morning Market Analysis Report:
  Why Brazil and Germany Will Outperform IMF Favorites China and India in 2010.
• Money Morning Special Investment Report:
  Germany: Emerging Market Profit Potential, With (Only) Developed Market Risk.
• The Economist:
  The Ost-mark's last laugh.
• Wikipedia:
  Ostmark.
• Bloomberg News:
  Merkel Wins Majority for Tax-Cut Coalition in Germany.
• Wikipedia:
  Deutsche Mark.
• MarketWatch.com:
  German ZEW index sees smaller-than-expected rise.
• Deutsche Welle (DW World):
  German coalition talks face tough challenges.
• CFD Trading:
  European Stocks Rally to New Highs on German Election and M&A Sentiment Boost.
• Wikipedia:
  The States (Lander) of Germany.
• Economist.com:
  Economic Forecasts.
• Wikipedia:
  Social Democratic Party of Germany.
• Deutsche Welle (DW World):
  Germany's Free Democrats pledge loyalty to a center-right coalition.
• Wikipedia:
  Peer Steinbruck.
• Bloomberg News:
  Germany Attacks 'Crass Keynesianism' of U.K. Stimulus.
• Library of Economics:
  Balance of Payments.

Tags: Angela Merkel, Brazil, Crass Keynesianism, Free Democrats, Germany, Guido Westerwelle, Martin Hutchinson