DIM PICTURE OF ECONOMIC SITUATION IN GERMANY DRAWN BY

UNCLAS SECTION 01 OF 02 MUNICH 000166

STATE FOR EEB (NELSON),EEB/IFD/OMA (WHITTINGTON),DRL/ILCSR AND
EUR/CE (SCHROEDER)
LABOR FOR ILAB (BRUMFIELD)
TREASURY FOR ICN (KOHLER),IMB (MURDEN,MONROE,CARNES) AND OASIA

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON PREL GM
SUBJECT: DIM PICTURE OF ECONOMIC SITUATION IN GERMANY DRAWN BY
INFLUENTIAL ECONOMIC THINK TANK

SUMMARY
--------------


1. At a conference celebrating the 60th anniversary of the
influential Munich-based think-tank, ifo, President Hans-Werner Sinn
dueled with German Federal Bank (Bundesbank) President Axel Weber on
the outlook for the German economy. Sinn, one of Germany's most
influential and most-quoted economists, drew a dim picture of the
situation in Germany, anticipating a drastic downturn in GDP and
increasing unemployment. He mainly held Germany's extreme export
orientation responsible for the steep recession and strongly
criticized governmental bailout initiatives. According to Sinn, the
overwhelming danger was deflation, not inflation, a point that Weber
pointedly disputed. A subsequent panel discussion focused on
renewing capital requirements for banks and finding a way out of the
ongoing crisis. Later at a private meeting with Embassy and
Consulate representatives, Sinn said that only German domestic
investments could fill the nation's demand gap. END SUMMARY

No Relief in Sight
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2. (U) Professor Hans-Werner Sinn opened the conference celebrating
the 60th anniversary of the influential think-tank of which he is
president, ifo, by painting a dreary picture of the German economy.
Although ifo's own widely-recognized economic barometer, the
"business climate index," tracked a more optimistic business
confidence in June, Sinn did not see significant signs of recovery
in what he called the crisis' "epicenter," the U.S. economy. Since
the German business cycle tends to lag that of the U.S. by a
year-and-a-half, Sinn forecasted that German unemployment would rise
dramatically until the end of 2010. He anticipated growth rates of
minus 6.3 percent for 2009 and around minus 0.3 percent for 2010.

Exports to blame
--------------


3. (SBU) Sinn saw Germany's over-dependency on exports as
responsible for the country's economic situation. With orders from
abroad decreasing by 41 percent, he suggested that Germany had
become a "shock absorber" for the international crisis. He
explained his theory by saying that in the U.S., China and UK,
imports decreased by much more than exports, causing a worldwide
drop in demand. Only Germany and Japan, where exports shrank more
drastically than imports, helped to compensate for this. (COMMENT:
In a subsequent meeting with Sinn, EconMin disputed this assertion,
noting shrinking German and Japanese current account deficits, while
welcome, had not stimulated world-wide demand. END COMMENT.) Sinn
also identified weak domestic investment as a fundamental "mistake
in the German business model." With its 4.1 percent net investment
quota, Germany is last among all industrial nations. Unable to find
profitable investment opportunities in Germany, capital had flowed
to foreign financial markets, and eventually to risky subprime
markets, he said. Sinn joked that the U.S. had effectively gambled
away German money.

"Bad bank" versus recapitalization
--------------


4. (U) Bundesbank president Axel Weber did not agree with Sinn on a
number of points, including the German government's bank rescue
plan. Where Sinn criticized the "bad bank" idea because it was
based on the shaky assumption that toxic paper would gain value
after the crisis, Weber supported the government's proposed scheme.
Getting bad paper off the banks' balance sheets would help them
raise new capital in financial markets, he claimed. Sinn instead
argued the government had no alternative but to become an active
shareholder in stricken banks in order to recapitalize them. At the
same time, Sinn did not foresee an increased danger of inflation
and, to the apparent irritation of Weber, contended that governments
needed to turn on the money spigot to avert a dangerous deflationary
spiral. Privately, however, Sinn defended Chancellor Merkel's
limited stimulus plan, and he faulted the U.S. stimulus package for
seemingly substituting excessive government spending for excessive
consumer spending.

Short-term bailouts versus long-term prevention
-------------- --


5. (U) A panel discussion featuring Professor Sinn, Bundesbank
President Axel Weber, HypoVereinsbank executive Theodor Weimer, and
Bavarian Finance Minister Georg Fahrenschon (CSU) rounded out the
event. All participants agreed that strengthening capital

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requirements for banks and improving banking supervision were
essential to avoid a repetition of the crisis. Fahrenschon and
Weber stated that the Basel II recommendations, with their limited
capitalization requirement and narrow European scope, were not
sufficient. In a new bank supervisory system, the Bundesbank would
have to play a key role, Weber said. Weimer added that the timing
of new credit requirement legislation was crucial. Increasing
capital requirements before a significant recovery from the crisis
could cause a credit crunch that would further harm industry.
Fahrenschon agreed and pointed out that banks should be pressed to
give loans to industry in return for governmental aid, as is the
case in Austria. Most of the discussion, however, centered on
different bailout models: mandatory capital injections (Sinn) versus
bad banks (Weber).

Sinn: More domestic investment and better supervision
-------------- --------------


6. (SBU) In a private meeting at the Ifo Institute the next day,
Sinn told EconMin Robert Pollard, Consul General Nelson, and ConGen
Munich staff that only German domestic investments could fill the
demand gap. This should occur in tandem with higher savings and
investment in the United States. Only investment meant real growth.
"Investing in more machines results in higher wages and more
consumption," Sinn said, and he recommended the same for the United
States. "Americans have been addicted to Champagne," he said.
"Foreign credit exporters like Germany paid for the Champagne. Now
the government pays." He said it was essential to reduce Wall
Street profits and to "make banking boring again." Sinn contended
that the German bank supervisor, BaFin, had also failed,
particularly in overseeing German banks' international businesses.
He added that, although other European countries had done a better
job in that respect, European credit requirements in general were
insufficient. "Basel II is not tougher than the current American
regulations," he said, adding that Basel II was not a meaningful
goal for the U.S. or the world. It was important to use today's
window of opportunity to increase capital requirements. At the same
time politicians needed to do everything possible to avoid a credit
crunch. Sinn advocated the recapitalization of stricken banks with
increased capital requirements, despite the fact that this would
make the bailout more expensive.

NELSON