Stalling German Economy Will Throw Gasoline on Eurozone Debt Fire

Germany's economy is slowing dramatically, an unwelcome turn of events that will put even more strain on existing fractures in the European Union (EU) as it struggles to cope with its ongoing sovereign debt crisis.

Last month a consortium of eight leading economic institutes slashed their forecast for German economic growth in 2012 by more than half, from 2% to 0.8%.

That decision was validated yesterday (Monday) when Germany reported a 2.7% drop in industrial production for September. That's the biggest drop since February 2009, and triple the decline that analysts had expected.

Worse, such a decline will make it even tougher for Germany, which has supplied the bulk of the bailout money that's prevented the Greek debt crisis from triggering a global financial meltdown, to play the role of hero in the European debt crisis.

"This is very, very serious on a lot of levels," said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "If Germany drops into recession the pressure on German banks will be extreme."

Fitz-Gerald said that the banks, as well as the German people, most likely would want to "bring their money home" to address Germany's own economic needs.

Of course, the loss of its greatest benefactor will have dire consequences for the Eurozone.

Fitz-Gerald thinks the situation could even reach a point where Germany would opt out of the common euro currency to save itself.

"Everyone's been talking about Greece leaving the euro," Fitz-Gerald said. "But Germany leaving is a real possibility, depending on how bad it gets. It's no longer inconceivable."

Catching the Contagion

Germany's economy is faltering mainly because of the problems plaguing its Eurozone partners. A report last week showed that orders for German industrial goods from other Eurozone members fell 12.1% in September following a 1.4% drop in August.

"German industry has finally caught the crisis virus," Carsten Brzeski, an economist in Brussels for ING Groep NV (NYSE ADR: ING), wrote in a research note. "The financial turmoil and the economic slowdown in other Eurozone countries have obviously spoiled the appetite for goods made in Germany."

Many economists now are worried that the entire Eurozone is heading into a recession, which will make it harder for countries like Germany and France to help struggling Portugal, Ireland, Italy, Greece and Spain (PIIGS).

"Possibly we will see, and I say this with all caution, a red zero in the fourth quarter," European Central Bank (ECB) executive board member Juergen Stark said in a speech last week. Stark said he expected "very weak" growth going into 2012.

European consumers have already started shutting their wallets. A retail sales report yesterday showed that September sales fell 0.7% in the 17 euro-sharing nations – far worse than the 0.1% economists had expected.

"Our view that the euro area would slide into recession in the current quarter appears to be playing out," said a report by JPMorgan Chase & Co. (NYSE: JPM). The report predicted a 1% contraction for the last three months of 2011, and did not foresee any growth until the fourth quarter of 2012.

Fractures in the Eurozone

As economic conditions deteriorate across the Eurozone, the joint architects of European debt crisis management, Germany and France, will become increasingly tempted to go their separate ways.

"The [German Chancellor Angela Merkel and French President Nicolas Sarkozy] relationship that's coddled the rest of the European Union is getting strained," said Money Morning Capital Waves strategist Shah Gilani. "Sooner or later one or the other is going to get caught considering dumping the other. If that happens, there is no European System of Financial Advisors. There is no more EU, as it exists at this moment."

But Gilani sees the possibility of an even deeper crisis arising from the German economy's troubles.

"Germany is to Europe what America used to be to the world," Gilani said. "In fact, Germany may be more than that these days. If it falters, that will send shockwaves around the globe."

With the euro binding the economies of Europe together, and the international banking system binding the rest of the world – including the United States – to Europe, a stalling German economy could set off a very unpleasant chain of events.

"Everything is interconnected: Banks, markets, and economies," Gilani said. "If Germany falters and slips hard on the banana peels that are the PIIGS, everyone will end up with broken body parts."

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